The most serious failure of Musharraf regime was its inability to address the inherent structural weaknesses of the national economy. The economic mandarins who were ushered into power by him were all partisans of the Voodoo magicians (new classical economists) who believe that withdrawing the state from the market is both necessary and sufficient for attaining potential output and steady state growth.

The present global financial turmoil illustrates the absurdity of this doctrine so dramatically that further comment becomes unnecessary.

Musharraf’s economic team has comprehensively dismembered monetary policy and laid the basis of a full fledged financial crisis. Their monetary policy has imposed a terrible cost on the poor.

This article will detail the cost borne by the poor of faulty monetary policy and outline some expectations of the poor from the new supposedly social democratic regime. (Remember roti, kapra aur makan).

The most painful cost borne by the poor of monetary policy is of course inflation. CPI growth rose from 7.8 per cent in FY07 to 12.0 per cent in FY08– a rise of over 50 per cent.

The inflation accelerated in the second half of FY08 after the SBP had raised the discount rate thrice, cash reserve requirements twice and statutory reserve requirements to almost 20 per cent.

A major cause of accelerated food inflation was the ineffectiveness of monetary policy measures in stimulating agricultural production, growth of which was halved – falling from 3.7 per cent in FY07 to 1.5 per cent in FY08. The SBP attributes this as it attributes almost all of its failures to “policy errors of the government”.

The State Bank puts the blame for all of the ills – high inflation external and fiscal imbalances and “crowding out” of private investment on government’s SBP borrowing.

However, the SBP Report FY 2008 presents no evidence estimating the actual contribution of the government’s SBP borrowing to the growth of inflation and external and fiscal imbalances. Attributing inflation to central bank borrowing by the government is an obsolete Voodoo doctrine discredited by post-Keynesian economists such as Goodley and Lavoie who demonstrate conclusively that this need not be the case especially when the economy faces cost push inflation as is the case in Pakistan.

In the SBP Annual Report 2008 blaming the post-Musharraf government for all policy failures of the State Bank is a constant theme. The State Bank under Shamshad Akhtar wants the PPP government to adopt a faulty policy stance cutting back all subsidies, abandoning the poor and mortgaging monetary sovereignty to the IMF.

Subservience to Voodoo monetarist doctrine has eroded the State Bank’s control over money supply; in FY08 reserve money grew by 21 per cent –faster than in FY07. The SBP’s policy transmission mechanism – the impact of changes in the discount rate on bank retail rates – weakened significantly, the rupee depreciated dramatically and the current account deficit rose to 8.4 per cent of GDP. All this says the State Bank report was exclusively due to the sins of the government especially its refusal to cut food and oil subsidies. The SBP is thus not responsible for anything.

The SBP can find no ground for blaming the government for the ineffectiveness of its interest rate policy in controlling private sector credit demand, so for this it blames NBFCs epecially mutual funds.

The SBP’s comprehensive failure in controlling inflation is reflected in the “trimmed mean core inflation” measure (a measure of inflation supposed to measure only those price changes influenced by monetary policy). This registered a year- on- year rise of 17.2 per cent by June 08 as against 8.7 per cent the previous year. The SBP presents no evidence to substantiate its claim that the FY08 inflationary pressures. “stems from global price shock”.

Empirical studies at CBM and PIDE show that this is not the case. Nor is there any evidence to show that the SBP has any capability to reduce the first round or second round pass through effects of rising global prices.

Quite the contrary, the SBP lauds the government’s “bold decision to pass on to the consumers the cost of imported inputs”. This will ensure “allocative efficiency”.

SBP recognition of the ineffectiveness of its tight monetary policy became evident in the first quarter of FY09 when it responded to the Pakistan market’s credit crunch by a drastic reduction in reserves, a massive liquidity injection through OMO’s and discount rate cuts, reduction of cash reserves requirements and abolition of SLR for a significant proportion of bank depositors.

SBP’s claim that “monetary over hang” was significantly reduced during FY08 is false. M2 grew by over 15 per cent in FY08. M2 has grown significantly faster than nominal GDP during most of FY00 to FY08 and Ishrat Hussain’s cheap money policy has been a major cause of accelerated inflationary pressure.

In FY08, the difference between M2 growth (16 per cent) and GDP growth (19 per cent) was small. The fall in M2 growth is entirely due to the negative growth of net foreign assets (minus 32 per cent) over which of course the SBP has no control. Had NFA growth been non-negative (zero) M2 growth would have significantly exceeded nominal GDP growth in FY08. During FY08 domestic credit net grew by 30 per cent and other assets net by 20 per cent. Actual M2 growth exceeded targeted M2 growth by 14 per cent. There is virtually no difference in the M2 growth rate of FY07 and FY08 if we exclude the exceptional M2 growth rate of June 2007.It is Ishrat Hussain’s policy of stimulating consumer credit demand which is hurting the poor. The incidence of inflation is highest on the lowest income group according to the State Bank which defines the lowest income group as those with income levels below Rs.3,000 per month. While the poor are starving, consumer demand remains strong. We continue to import Cadillacs from America and perfume from Paris. It is this artificially bloated consumer demand which has led to the explosive growth of the current account deficit and the massive draw down of foreign reserves in FY08.

The policy makers loss of control over the macro economy is illustrated by the dramatic change in the overall external balance. The FY07 surplus of $ 3.7 billion was converted into a huge deficit of $5.8 billion in FY08. Inflow of foreign capital also decelerated significantly during FY08. Monetary policy has been as ineffective in stabilising foreign capital flows as it has been in restraining consumer credit demand.

The ineffectiveness of monetary policy is also reflected in the deceleration of bank deposit growth. Deposit growth declined by more than 25 per cent in FY08 compared to FY07 despite the rise in interest rates. Interest rate changes also did not succeed in reducing bank lending to the private sector. Bank advances growth was concentrated in the corporate sector and was for working capital and trade financing. Advances for fixed investment declined during FY08 and the agriculture and the small scale sector remained acutely credit starved.

Decline in deposit growth was accompanied by a drop in the over all M2 to GDP ratio. This was also the result of decline in NFA and indicates the increased external sector vulnerability of the tottering monetary management system. The sharp increase in the currency to deposit ratio in FY08 indicates the lack of confidence of the public in the banking system. This is also reflected in the rapid growth of foreign currency deposits during FY08. Rising risk is also indicated by the sharp rise in the credit / deposit ratio which at end of FY08 exceeded 82 per cent.

The SBP jacked up the interest rate structure during FY08 but average deposit to average lending rate spread remains at about seven per cent. Foreign bank lending to deposit rate spread has increased and most foreign banks continue to ignore the five per cent saving deposit rate floor set by SBP, on one pretext or another.

SBP’s liquidity management was also a failure –as usual, the SBP blames the government for this. Overnight repo rates remained highly volatile. The SBP failed to retain commercial bank interest in TB auctions which is the main reason behind expanded government borrowing from SBP. Increase in TB cut of rates was quite ineffective. Debt maturities roll over proved to be very inadequate. Investments in PIBs fell by more than 20 per cent during FY08.

Market based monetary policy has, during FY00-FY08, manifestly failed to achieve its objectives – ensure monetary stability, control inflation, effectively regulate reserve money and credit money growth. But its greatest crime is that of omission. The SBP prides itself on having no distributional targets. What this means in practice is that the SBP encourages the scheduled banks to play an exploitative role.

This becomes evident when we look at the distribution of bank deposit and credit accounts. Banks are serving as a vehicle for transferring billions of rupees from the poor to the rich every year. This is where their profits come from.

In 2008, those with deposits of less than Rs0.1 million each (the poor) held 78 per cent of the total number of bank deposit accounts. However, their share of the total amount in these accounts was only 15 per cent. As against this, those with more than Rs5 million in their accounts had less than 0.1 per cent of the total number of bank deposit accounts but their share of total bank deposits was 37 per cent.

In 2008, the poor (those with less than Rs0.1 million each) had 68 per cent of total bank advances accounts but their share in bank advances was less then 0.6 per cent.

As against this, the share of those with more than Rs5 million in their advances accounts was only five per cent of the total number of advance accounts but their share of total amount lent by the banks was over 70 per cent.

Banks transfer funds from the poor to the rich. Total deposit of the poor (those with less than Rs0.1 million) amounted to Rs584.7 billion in 2008. The total amount lent to them by the banks was only Rs28.8 billion.

The total amount lent to the rich (those with investment account limits in excess of Rs5 million) was Rs1973.8 billion. The deposits of the rich in 2008 were Rs1394.5 billion–thus the banks transferred Rs594.3 billion to the rich. This transfer of money from the poor to the rich has happened every year during 1999 to 2008. During this period, according to one CBM estimate, at least Rs3 trillion have been transferred from the poor to the rich by the banking system.

The vast majority of the population have no accents to the banking system. The number of deposit accounts have been falling every year during FY2000 to FY2008. In FY2008, there were only 24.9 million deposit accounts. Depositors, of course, have several accounts each. According to NBP research, the total deposit accounts to total depositors ratio is 1.4. This means that only about 18 million people in a population of 163 million have bank deposit accounts, 89 per cent never need to open the door of a bank.

This grotesque mal-distributive financial system preys upon the poor. Its distortions are accentuated by market based monetary policy which presumes the universal validity of Voodoo macroeconomic theory.

Voodoo (representative agent) macroeconomics presumes that:

• Money supply (especially reserve money) is an exogenous variable.

• Saving, investment, bank lending etc. are sufficiently interest elastic to make the central bank chosen interest rate structure a fulcrum in the monetary policy transmission mechanism.

• An optimum output maximising real sector equilibrium is automatically generated when the central bank chooses the “right” interest rate structure and this also automatically generates a welfare maximising pattern of income distribution.· Government borrowing from the central bank is necessarily inflation enhancing and therefore fiscal policy should be subordinated to monetary policy.

Post Keynesians and Neo Saraffn’s have detailed the grotesque deliberate misrepresentation of capitalist order functioning that is implicit in these assumptions. Extensive research at PIDE, CBM and AERC has shown that the Pakistan economy certainly does not work in this way. Neither investment nor saving nor bank credit is interest elastic. Both M2 and Mo are endogenous variables; manipulating interest rates is not an effective way of influencing macroeconomic aggregates.

“Equilibrium” generated by accommodation to market investment and consumption preferences does not yield stable or sustainable or equitable growth. There is no proof that central bank borrowing by the government is inflation enhancing.

Increasing low cost public borrowing is an indispensable necessity for increasing the real income of the poor, significantly expanding public investment and loosening the stranglehold of multinational agencies on policy making. If the PPP is seriously committed to a social democratic policy agenda, it must:

• abandon market based monetary policy due to its comprehensive systemic failure and recognise the reactionary character of the Voodoo macroeconomic theoretical paradigms which underlies it.

• reinstitute credit planning. This requires a leadership with hands on experience of credit planning.

• monetary policy objectives should be distributional not macros aggregative. A growing real or financial market does not take care of the poor. That is why the state must govern the market by becoming a major consumer and investor.

• abolish the autonomy of the SBP (this has transformed it into pro-West Currency Board), nationalise all banks and NBFCs and impose strict capital controls on both current and capital account transactions.

The PPP will, of course, do none of this. The PPP has already finalised a medium-term agreement with the IMF which gives the IMF policy oversight rights. But failure to address distributional inequities will discredit the PPP.