Independent central bank

BY R I A Z R I A Z U D D I N 2023-02-10
READERS may remember there was much hue and cry over the
amendments to the State Bank of Pakistan Act, 1956, that were legislated in
January 2022. The present government, then in the opposition, had
resisted it tooth and nail but let the law pass thanks to establishment
pressure not necessarily as a reform measure but an obligatory IMF
condition. The government`s concept of the central bank`s independence
should be taken with a grain of salt as the government itself is not
independent of the establishment. Despite this conundrum, the SBP has
become relatively more independent after these amendments. Since the
raison d`être of central bank independence lies in the fact that the higher
the degree of independence, the better the control over inflation in the
country, the independent central bank must cogently justify the presence of
high inflation.

The independent SBP is required to submit three reports to parliament: the

governor`s annual report on SBP performance, a half-yearly report on the
state of the economy, and an annual report on financial stability. For the
SBP as an independent institution, the governor`s report is the most
important because its contents are `regarding the achievement of the
bank`s objectives, conduct of monetary policy, state of the economy and the
financial system`. Since the `primary objective of the bank shall be to
achieve and maintain domestic price stability`, the governor`s report must
discuss the achievement of this objective along with the two non-primary
aims of `contributing to the stability of the financial system of Pakistan`
and supporting the government`s `general economic policies with a view to
contributing to fostering the development and fuller utilisation of
Pakistan`s productive resources`.

The governor`sAnnualReport2021-22 discusses all three objectives,

although it devotes more pages to listing various measures to support the
government`s economic policies compared to the space devoted to
discussing its primary objective of achieving price stability. Although the
difference is of only one page, it gives the impression that price stability is
not the primary objective.

There is no point in making a fuss about an addi-tional page on growth

promotion as this is no proof of SBP bias against containing inflation, but it
is an unconscious indication of the bank`s bias towards growth promotion.
To its credit, the report frankly admits that one factor causing high inflation
is the accommodative monetary policy. What is surprising is that the report
seemingly congratulates itself on its inflation forecasting performance even
when it has missed meeting its medium-term inflation target of seven to
nine per cent.

Self-congratulations, however, indicate an internal strength of the SBP

monetary policy and research staff. It must have been rightly alerting the
SBP management and Monetary Policy Committee to make timely changes
in interest rates and also likely to have been pointing out the misalignment
of the exchange rate. The MPC`s judgement and decisions cannot be simply
based on the difference between forecast and actual inflation, interest rate
and exchange rate. The MPC has to take a holistic view of the economy and
financial sector. But it may be unconsciously influenced by the noise, if not
direction, coming from the government to err on the accommodative side.

Recent research in America has established that the incessant noise

emanating from former president Trump`s tweets about interest rates and
what the Fed should or should not do, changed the expectations of market
participants that influenced the Fed`s decision regarding its policy rate.
Similarly, when the authorities make a lot of noise via press conferences
about what ought to be the right policies or desired level of interest or
exchange rate, it affects market expectations in Pakistan. In these
situations, it becomes easier for the monetary authorities to be influenced
by the government even when they are actually independent. Just look at
the behaviour of the exchange rate, if not necessarily that of the interest
rate, and you will understand the truenature ofSBPindependence.

How independent is the MPC? A review of the MPC`s minutes shows that
it`s quite independent, except that it is not empowered to correct
misalignment in the exchange rate if it exists. And it seems afraid to even
discuss the exchange rate`sbehaviour. Hence, monetary policy formulated
by the MPC remains very weak, even when it is fully independent in its
decisions regarding interest rates. But it also seems afraid to reveal
members` discussion on interest rates. The MPC`s minutes read mostly
like the minutes of the presentation by SBP staff to the MPC. The list of
members of the MPC in the minutes and the last few sentences indicate that
they were present at the meeting but hardly any discussion seems to have
taken place.

For example, in the minutes of the meeting in July 2021, the monetary
policy deliberation and decision vote took up only one sentence, `The
committee decided to keep the policy rate unchanged with a majority vote
of eight out of nine members, with one member voting to increase the
policy rate by 50 bps`. This sentence was also the last of the 26-paragraph
minutes.

The other 25 paragraphs were about the SBP staff`s briefings on the
current economic conditions and outlook, financial markets and reserve
management, model-based assessment and the result of SBP surveys for
monetary policy. One is left unsure about whether the SBP staff moulded
the MPC`s decision or the MPC decided independently. This, of course, is a
weakness in the way the minutes are structured and written. The MPC must
allow the writers of these minutes to capture their members` deliberations
without revealing their identities, or if they so desire, give their names.
What are they afraid of? After all, SBP became independent for the most
part, except for the exchange rate, in January 2022.

Despite the weaknesses, one must congratulate the dissenting member who
saw the crisis coming at that time and suggested timely action for
tightening the monetary policy. Dissent and suggestion probably came from
an external independent member. Later meetings (FY22) saw unanimous
decisions on tightening. This shows that the SBP`s MPC is independent in
its interest rate settings. • The wnter is a former deputy govemor of the State
Bank of Pakistan.