Nothing seems to hurt Pakistanis more on a daily basis than inflation. Indeed, it is a country where many have to skip a meal at times. That is why one wonders why there is such a polarised debate on the proposed amendments to the State Bank of Pakistan (SBP) Act, 1956, which seek to focus the SBP on domestic price stability and enhance the independence and protections for those entrusted with running it.

The proposed amendments seek to change both the objectives and the functions of the SBP. Domestic price stability is to become the primary objective of the SBP, followed by financial stability, and then support for the government’s economic policies to foster development.

There will be tighter restrictions on government borrowing from the SBP. The Monetary and Fiscal Board shall be discontinued and replaced with direct coordination between the finance minister and the governor.

A misplaced debate

Whenever an institution is required to do its job free of interference from politics and special interest groups, institutional autonomy is essential. Indeed, financial independence, operational autonomy and/or legal protections to the office bearers are already included in the SBP Act and that of other regulatory authorities.

The central bank would have a much better chance of managing inflation if domestic price stability is its primary function

Consider for instance section 3(3) of the Securities & Exchange Commission of Pakistan Act, 1997: “The Commission shall be administratively, financially and functionally independent and the federal government shall use its best efforts to promote, enhance and maintain the independence of the Commission.”

The SBP’s website notes: “Under financial sector reforms, the State Bank of Pakistan was granted autonomy in February 1994,” and section 46B(2) of the SBP Act makes a clear reference to the bank’s autonomy. Over the years, there have been a series of amendments to the SBP Act and the proposed amendments are neither the first nor the last. One way or the other, the federal government will have a say regarding who is appointed for a key position.

There is nothing unprecedented about the autonomy amendments. For instance, one can find various examples of a five-year renewable term for the governor of the central bank, such as Australia, New Zealand, Indonesia, and Malaysia. A 2009 report by the Bank of International Settlements shows that of the 47 central banks analysed, only 6 per cent had a three- to four-years term for the governor whereas 64pc had a five- to six-years term.

It is well known in Pakistan that the fear of hounding by agencies encourages the civil bureaucracy to avoid taking decisions and it makes sense to protect actions taken in good faith. Our problem isn’t that we don’t provide legal protections to office-bearers but that these protections do not withstand the test of time. It was as recent as May 2019 when despite the three-year term provided in the current SBP Act, the governor at the time was forced to resign. In this sense, the debate on SBP’s autonomy is fundamentally misplaced.

The relevant debate is how to enhance the independence and autonomy of not just the SBP but all the other pertinent bodies in the country, such as the Securities and Exchange Commission of Pakistan, Competition Commission, Higher Education Commission and so on.

An uneasy balance

A typical company’s CEO is appointed by its board, he/she is accountable to the board and risks losing his/her job if (s)he fails to meet the performance targets typically around profitability. But traditional corporate governance does not fit the central bank and regulators that are meant to work in the public interest. In such cases, there is an inherently uneasy balance between accountability and autonomy.

Critics of the amendments are overlooking the fact that there is no hard accountability in the current SBP Act either. Consider that if the governor SBP had a direct reporting line to the finance minister with hire and fire authority, it would be seen as forcing the central bank to follow the whims of the minister. That would defeat the very purpose of separating the monetary policy from the government.

Another factor complicating things is that within central banks and regulatory authorities, performance can be difficult to measure and attribute. This is why accountability measures for central banks and regulators are transparency measures. Examples include presenting to parliament and answering questions, publishing reports on the state of the economy, releasing minutes of meetings, holding press conferences and being subject to a microscopic analysis by the financial markets.

The debate continues

The current SBP Act refers to monetary stability, which could be interpreted to include inflation. There are repeated references to inflation in the opening paragraphs of the SBP’s monetary policy statements and the context suggests inflation is very much on the minds of those issuing these statements. That SBP should move to inflation targeting was being debated by the SBP staff for well over a decade.

According to a publication by an economist from the International Monetary Fund (IMF), 38 central banks from across the world including both developed and developing countries were practising inflation targeting as of 2015. It is also not unusual for some central banks to practice implicit inflation targeting and the US Federal Reserve is believed to be doing the same.

If the amendments are approved, the SBP would follow a disclosed target range, presumably set by the National Economic Council, for inflation and raise or lower interest rates to steer actual inflation towards the target range. Conventional economics assumes that raising interest rates is likely to cool off the economy and slow down both demand and thereby inflation and vice versa.

But economics, also called the dismal science, is just not physics. Massachusetts Institute of Technology Professor Andrew Lo explains that contrary to physics, in economics, there are 99 laws to explain 3pc of the phenomena. Inflation targeting emerged in the 1990s when, contrary to what was believed earlier, economists became convinced monetary policy had an impact on inflation. As you would expect, the empirical studies for and against inflation targeting remain divided but it appears that IMF favours it.

When inflation targeting influences inflation, it does so indirectly and with a lag. In a country like Pakistan, there are many factors affecting inflation that have little to do with monetary policy, such as currency devaluation, cartelization, inefficiency in energy production and distribution. It is well near impossible to quantify and attribute how much inflation was caused by what reason. Having said that, the SBP would have a much better chance of managing inflation if domestic price stability is its primary function.

The writer is a former CEO of the Audit Oversight Board and Executive Director at the Securities and Exchange Commission

Published in Dawn, The Business and Finance Weekly, May 3rd, 2021