SBP autonomy must be complemented with broader economic reform
https://arab.news/22qkf
The Pakistan government has decided to enact legislation to finally establish the autonomy and independence of the State Bank of Pakistan (SBP). Through the abolition of the Monetary Policy and Fiscal Coordination Board, whose members included nominees of the Federal Ministry of Finance, the enactment would limit the government’s ability to interfere in the SBP’s independent implementation of monetary and exchange rate policies.
The proposed legislation not only looks to reform the central bank’s governance, but more importantly to make the central bank’s sole mandate that of maintaining price stability. SBP is likely to adopt a technique called inflation targeting, in which the central bank makes public a projected, or target, inflation rate and then attempts to steer actual inflation toward that level, by adjusting monetary policy.
Since interest rates tend to move up in order to control inflation, and ease up when inflation is low, raising or lowering interest rates becomes more transparent under an inflation targeting policy. While this policy has been successfully implemented in several developed economies, where it has led to increased economic stability, there are concerns about its impact on growth in a relatively poorer developing country like Pakistan.
Critics of a fully autonomous SBP fear that the central bank could wield excessive power and influence over the economy, and design policies that can potentially frustrate the will of the people. For example, voters may elect a government to boost growth and create jobs, but the central bank could decide to keep interest rates high, and consequently hinder the government from delivering on its election promises. This could create tension between an elected government and unelected central bankers whose primary objective has become to maintain price stability.
While the government has stated that the SBP will be accountable to the parliament, it presently remains unclear how and over what periods the target range for inflation will be specified. In the absence of such a target range, an implicit inflation targeting regime may fail to instill the credibility that is essential for effectively signaling the central bank’s intention and will to maintain price stability.
Javed Hassan
In common with many other developing economies, Pakistan has had a history of high fiscal deficits and high inflation. In order to improve their electoral chances, politicians are tempted to resort to deficit spending to boost growth and create jobs, and more egregiously, to provide handouts in the form of subsidies (to industry and agriculture) and high commodity support prices (to the agricultural sector) as well as ad hoc pay increments and perks to an already bloated civil service. While catering to various interest groups serves short-term political motives, they inevitably heighten inflation expectations, increase inflation volatility and result in interest rate uncertainty, which in turn inhibit long-term growth in output.
Limiting the adverse consequences of deficit spending provides the clearest case for an autonomous central bank with the independence to conduct policy that is free from direct political or governmental influence. The new regime, as proposed in the legislation, also precludes the government’s ability to directly finance its expenditure by borrowing from SBP. It will expose the government to market imperatives and place external fiscal discipline that should discourage governments from fueling unsustainable growth on the back of excessive borrowing.
The tensions between the desire of politicians to boost growth and provide employment versus the central bank’s mandate of controlling inflation may be addressed by an explicit commitment to meet a specified inflation rate or range, within a specified time frame that is reviewed and agreed with the government and the parliament. In effect, the regime will rest upon setting a clear target with an unambiguous mechanism for SBP to regularly communicate and be responsive to public representatives.
While the government has stated that the SBP will be accountable to the parliament, it presently remains unclear how and over what periods the target range for inflation will be specified. In the absence of such a target range, an implicit inflation targeting regime may fail to instill the credibility that is essential for effectively signaling the central bank’s intention and will to maintain price stability. Market participants could be left speculating what inflation will be over the long-term, and the uncertainty around the central bank changing its target in the future could undermine the potential benefits of autonomy and adopting an inflation targeting regime.
It also important to note that the successful adoption of inflation targeting in developing economies has been accompanied by broader policy measures and investments to mitigate against supply side constraints that can lead to commodity shortages and precipitous price hikes. These include development of cold storage facilities for food commodities and reductions of protective tariffs to allow free flow of goods across borders. Also, since inflation targeting depends on the interest rate channel to transmit monetary policy, it is crucial to broaden and strengthen the financial sector. If Pakistan fails to adopt broad-based reforms across the economy, an autonomous SBP may find accomplishing its key policy objective to be an uphill task.
While the move toward SBP’s greater autonomy has to be welcomed, this must be complemented with increased transparency, and fiscal and trade policies that reflect a comprehensive economic, not just monetary, policymaking framework.
– Javed Hassan has worked in senior executive positions both in the profit and non-profit sector in Pakistan and internationally. He’s an investment banker by training.
Twitter: @javedhassan
