Monetary policy - Dr Muhammad Yaqub - Wednesday, March 02, 2011

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The Senate Standing Committee on Finance is reported to have raised an important legal point in one of its recent meetings about a mandatory requirement under Section 9B of the State Bank of Pakistan (SBP) Act. The requirement is that of holding a quarterly meeting of the Monetary and Fiscal Policy Coordination Board headed by the Federal Minister of Finance and including, among others, SBP governor as its member.

Noticing this violation of the SBP Act during the last several years, former deputy governor of the SBP Muhammad Ashraf Janjua, had written several articles in daily English newspapers drawing the attention of the Ministry of Finance and the SBP to this glaring violation of the SBP Act. Nobody paid any attention to his articles. It is encouraging to note that the Senate Standing Committee on Finance has taken notice of this violation and is likely to take up the matter again in its meeting to be held on March 3, 2011.

As I was mainly responsible, being governor of SBP at the time, for the drafting of section 9A and 9B of the SBP Act that was passed by the National Assembly first in 1993 and further in1997, I thought it will be useful to give a brief background and its modus operandi.

Until 1993, the SBP was both legally and practically totally subservient to the Ministry of Finance and monetary policy was completely subordinated to fiscal policy so that the government could borrow at will any amount from the SBP through the creation of ad hoc treasury bills and from commercial banks under any arrangement, including simple directives. This was playing havoc with the banking and monetary system of the country and fueling inflation.

Accordingly, in 1993 the Benazir government introduced amendments in the SBP Act to, inter alia, grant some autonomy to the SBP in the conduct of monetary policy. This was followed by further amendments in 1997 when the Nawaz Sharif government agreed to incorporate some changes in the above sections of the SBP Act for the dual purpose of giving more autonomy to the SBP in the formulation and implementation of monetary policy and simultaneously clarifying the mechanism for an effective coordination with the fiscal policy.

Section 9A of the SBP Act gave autonomy to the SBP to “determine and enforce, in addition to the overall expansion of liquidity, the limit of credit to be extended by the Bank to the federal Government, Provincial governments and other agencies of the federal and Provincial Governments for all purposes”. Section 9B of the SBP Act set up the Monetary and Fiscal Policies Coordination Board for the “coordination of fiscal, monetary and exchange rate policies” through mandatory quarterly meetings.

Meetings of the Monetary and Fiscal Policies Coordination Bard were held regularly when I was governor of the SBP; the latter formulated and conducted an independent monetary policy and coordinated it with the fiscal policy through the mechanism of quarterly meetings of the board set up under the amended SBP Act.

Under these provisions of the law, proper sequencing for the formulation and implementation of monetary policy that was adopted after the above amendments, and was to be to be adhered to thereafter, was as follows:

•Much before the beginning of the fiscal year the Monetary and Fiscal Policies Coordination Board met and agreed on the targets of inflation, rate of economic growth and changes in net foreign assets in the forthcoming fiscal year.

•Based on its framework for economic analysis and demand for money function, the SBP determined the safe limit of monetary expansion for that year that was consistent with targets of growth, inflation and net foreign assets.

•The SBP estimated genuine credit requirements of the private sector in consultation with the representatives of the private sector and relevant officials of the government for that year

•Using its reserve money program, SBP estimated the scope of government borrowing from the SBP and of indicative amount of government borrowing from commercial banks that was consistent with inflation, growth and balance of payment targets.

•The above estimates were approved by the central board of the SBP and the approved overall credit program was forwarded to the Ministry of Finance which used it as an input for developing the financing scheme of the budget.

•The SBP implemented monetary policy and Ministry of Finance based its budget on bank financing emerging from the monetary policy targets.

•A review of developments was undertaken in quarterly meetings of the Monetary and Fiscal Policies Coordination Board to make any adjustments and to ensure consistency in fiscal and monetary policies.

It remains a mystery as to why and when the above legal framework was abandoned by the Ministry of Finance and the SBP after my retirement.

It may be added that the new amendments proposed in the SBP Act are paraded as if they will enhance SBP autonomy. In reality, it will make monetary policy again subservient to fiscal policy and to the Ministry of Finance. The responsibility for enforcement of new provisions, if enacted, will rest with the Ministry of Finance which has a poor track record in this regard. The Ministry of Finance may not honour its commitments in this regard as it hasn’t done so with regard to the Fiscal Responsibility Act.

It is not more changes in the law but a sincere implementation of the existing provisions of section 9A and 9B of the SBP Act that would ensure relative monetary stability and also protect the private sector from paying the price in the form of higher interest rates and lower availability of credit because of excessive government borrowing from the SBP.

The writer is the former governor of State Bank Pakistan

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