LAHORE: The State Bank of Pakistan (SBP) will discontinue quasi-fiscal operations or monetary actions it undertakes on behalf of the government but keep refinancing facilities it uses to support access (of various sectors of the economy) to subsidised credit, even after the passage from the parliament of amendments to the existing SBP Act of 1956.

“A central bank should have quantitative tools in its arsenal. If we did not have these tools, we would not have been able to support the economy and business during the Covid-19 crisis through a reduction in the interest rate and boost investment through long-term, cheap loans under the Temporary Economic Refinance Facility (TERF),” a central banker elaborated in a background briefing on the suggested amendments to the SBP law of 1956 that seek to redefine its core objectives, give the bank and its governor unprecedented powers, and preclude political influence in determination of monetary policy and exchange rate policy.

The amendments propose to reset domestic price stability or inflation targeting as the SBP’s primary objective, freeing it from responsibility of supporting growth, and barring it from directly lending to the government. Financial stability is defined as its secondary objective and support to the government’s economic policies to foster development and fuller utilisation of resources as its tertiary objective. At present, its core responsibility is to secure monetary stability and support the government’s growth objectives.

Official points out if the new model doesn’t work, parliament is empowered to change the law again

Ever since the approval of the draft SBP Amendment Bill 2021 by the cabinet to meet one of the key prior actions for revival of the $6 billion IMF loan, the market is abuzz with reports that the SBP may discontinue subsidised loans for promoting housing sector, small and medium industries, agriculture, exporters, etc, which it provides to commercial banks and other financial institutions for disbursement among their customers.

“The amended SBP law allows us to keep refinance facilities in the central bank’s arsenal and use them in pursuit of its redefined mandate of price and financial stability. It doesn’t mean we are going to rely on it heavily or constantly; it just means that our toolkit should be sufficiently strong to enable the central bank to inject liquidity (in the economy) when there’s a need (for it).

“But we wouldn’t be able to do so when (the) economy is overheated, output gap is positive, investment is rising very rapidly and inflation is high because of the demand side factors. In that kind of situations, more liquidity would undermine price and finance stability,” he said on condition of anonymity as he is not authorised to speak publicly.

While making refinance schemes available for exporters, agriculture, small and housing sectors, investment, and others, the central bank will not ‘insure risk of any sector or give credit guarantees’. Credit risk and decision-making will remain with the lending banks and financial institutions for ensuring credit discipline and appropriate credit allocation. Additionally, the SBP will not prioritise any bank or financial institution.

“If these two criteria are met SBP can provide refinance. This is exactly what we did with our concessionary TERF scheme, which clearly targets investment with credit risks and decisions resting with the lending bank. We only hold the lenders accountable for the quality of their decisions,” the anonymous central banker argued.

Going forward, the SBP would like to scale down (refinancing operations) when the government creates a good EXIM bank and development financial institutions (DFIs). As long as this does not happen the refinancing facility will likely continue. “There are many ‘ifs’ and ‘buts’ in the existing law. We think we should have more flexibility to take measures like TERF in emergency situations like the Covid-19 crisis. For this, a whole new section is added on refinance facilities and their terms and design,” he said, claiming the confusion over subsidised lending schemes was spawned by an old draft being circulated on social media.

Government borrowing

The proposed changes in the law forbid the central bank from lending directly to the government for financing its deficit. “It’s a policy decision taken to ensure fiscal discipline. Yet it doesn’t stop the SBP from lending to the government by purchasing its debt from the secondary market. This kind of intervention helps the government in price discovery so it exactly knows the cost it’s paying to the market besides deepening the money market by improving its size,” the central banker explained. Even right now open market operations are used for injecting liquidity in the market to enable commercial banks to purchase government debt.

Although the government is zero-borrowing from the SBP as part of the IMF programme’s conditions, the approval by the parliament of the amended law will bar it legally from forcing SBP to print new currency notes to finance its budget deficit. Even under the present arrangement, the government has to repay loans to the SBP at the end of each quarter for achieving zero borrowing on a quarterly basis.

Independence

The proposed changes in the SBP Act, from the perspective of the central bank’s present management, seek to clearly redefine objectives, boost its functional and institutional autonomy to achieve them and strengthen its accountability in achieving its objectives. “If the objectives aren’t clear, accountability will not be clear; in order to achieve the objectives and ensure transparency in operations, necessary resources — international resources, and financial and administrative autonomy — have to be made available to the central bank to take decisions without any external influence or involvement,” a simplified version of the draft bill prepared by the finance ministry reads.

“The suggested changes in the existing SBP law will place the central bank in a much better position to target price and financial stability and managing the currency through independent determination of monetary and exchange rate policies, besides resetting its core objectives and preventing frequent political interventions in its decision-making and operations,” the central banker elaborated.

“All stakeholders — SBP, government and IMF — are of the view that the benefits of autonomy outmatch concerns,” he went on, adding it was incorrect to say that the amendments to the law were being rushed under the IMF pressure. “We have been working on it since 2015 and its part of efforts to update the law in accordance with the changing role of central banks the world over.”

The central bankers complain that the critics of the bank’s independence had ignored the important issue of inflation. “Stable macroeconomic environment is very important for growth, and avoid the frequent ‘boom-and-bust’ cycles. When such cycles are more frequent it means something is wrong with the economy. Sustainable growth requires a stable macroeconomic environment including reasonable price stability in the economy. Inflation is worst sort of tax on the poor segments. Inflation makes people with access to assets get richer, and those without assets get poorer. The result is further… inequality,” the central banker contended.

Besides establishment of a close liaison between the SBP governor and finance minister after the dissolution of the Monetary and Fiscal Policies Coordination Board under the amended law to “keep each other fully informed” on all the matters that concern both, the central bank will also be answerable to the parliament.

“The board is proposed to be abolished because it undermines independence of monetary policy committee. Some past experiences under the previous administration (of PML-N) wherein interventions were made to manipulate the interest and exchange rates. Consequently, we accrued trade deficit of $19bn and returned to the IMF. If it hadn’t happened and if the central bank had autonomy in its determinations we wouldn’t have to go to the IMF.”

He rejected a suggestion that approval of the proposals would create a “state within the state” in the form of a central bank that would not be answerable to anyone, including the parliament. “The amended Act doesn’t preclude changes in it by the future parliaments. If the new model doesn’t work, the parliament has the powers to reverse the changes or introduce new ones. We have pursued the existing model for a long time and look where we are at now. If powers were not misused in the past and SBP not made to print money to fund deficit or manipulate interest and exchange rates, we would not need these changes. Clear articulation of the objectives and alignment of the SBP’s functions with them will protect it from political influence in future.”

Published in Dawn, March 28th, 2021