Setting the Scene
Setting the Scene
The Economic Advisory Group (EAG) met to deliberate on central bank autonomy in the context of the SBP Amendment Act, 2021, which the federal cabinet passed last week.
The bill advocated for more autonomy for Pakistan’s central bank, its independence from the Ministry of Finance, and the abolishment of the Monetary Policy and Fiscal Coordination Board.
EAG agreed that more autonomy for the State Bank of Pakistan (SBP) was a move in the right direction, but members shared their concerns and reservations.
More autonomy ensures SBP operates independently of government interference. This shift makes price stability the key concern for the SBP, freeing it of the whims of ministries and the burden of financing the government’s deficit. Some members pointed out that limiting government’s ability to directly finance its expenditure through the central bank will expose the government to market conditions and facilitate fiscal discipline. It was also highlighted that, despite concerns around inflation in developing economies driven by supply side factors, inflation targeting is being globally adopted by developing economies and evidence from across the world corroborates its effectiveness.
Addressing the accountability related concerns, EAG pointed out that a move towards an inflation targeting regime automatically makes the State Bank more accountable besides increasing its autonomy. Inflation targeting also reduces currency risks and helps anchor inflation expectations, thus increasing the effectiveness of monetary policy in managing business cycle fluctuations.
However, the key question that remains unanswered is: what will be the golden number or inflation band – the inflation target, and who will set it, given weak institutional coordination in the country.
Effective regime change for the SBP requires setting a clear band. In the absence of such a target, Pakistan would be adopting an implicit inflation targeting regime (like the US Federal Reserve), which may be ill suited for Pakistan. Such a regime critically depends on the credibility of the central banking institution and is often criticised for its lack of transparency. Moreover, monetary policy passes through credit channels; in Pakistan the dominant channels take much longer as compared to the channels of advanced countries like the USA.
It was added that in the absence of a clear inflation band, market participants will be left guessing what inflation will be over the long-term. The uncertainty around the central bank changing its target in the future will undermine the benefits from adopting an inflation targeting regime. Likewise, the transparency and accountability promised in the proposed bill also becomes a pipe dream, in the absence of a clear target range, as the parliament cannot hold the SBP accountable for under or overshooting a target that was not defined beforehand. EAG called for clarity from the government regarding these key concerns.
Further, the limitations of demand-side management of inflation (i.e. monetary policy) was also brought into the light. The significance of supply-side factors, including free flow of goods across national and international borders and facilitating development of cold storage facilities, was highlighted. It was agreed that an independent central bank will still continue to fall short of meeting its objective of price stability if the economy continues to face supply side disruptions.
EAG members expressed their support for autonomy, while asking the government to initiate a public debate on this vital issue to address these concerns, and to harness ownership of institutional stakeholders without which long-term sustainability of the reforms will remain doubtful.
EAG is an independent group of economists, policy analysts, financial experts, and academics that deliberate on Pakistan’s economic policies. The fourth meeting on the “State Bank’s Autonomy” was attended by, Dr. Aadil Nakhoda (Assistant Professor, IBA Karachi), Dr. Ahmed Jamal Pirzada (Assistant Professor, University of Bristol UK), Ali Salman, (Managing Trustee, PRIME), Samir Ahmed, (CEO, Knightsbridge Capital Group), and Mueen Batlay (Director, Hamdard Institute of Management Sciences).
Media Mention: The Nation and THE NEWS