As the economic crisis in Pakistan has worsened, a lot of criticism has been directed at the ruling PDM coalition, with a particular focus on Finance Minister Ishaq Dar. In addition, many who had been warning about the looming economic crisis began doing so when Imran Khan’s PTI was in power, with Shaukat Tarin revving up the economy at a time when it needed to be cooled down.

All of this criticism is valid and legitimate, but it is equally important to remember that the State Bank of Pakistan (SBP) also had a key role to play in fanning the flames of this crisis.

The State Bank of Pakistan Act, 1956, gives the SBP the following mandate:

• achieve domestic price stability by way of regulating the monetary and credit system,
• contribute to the stability of the financial system, and
• support the government’s general economic policies to foster development and fuller utilisation of the country’s productive resources.

The above basically means that it is the central bank’s responsibility to prevent runaway inflation, ensure that systemic financial risks do not materialise, and maintain a stance that promotes development and optimal resource allocation. In addition, the legislation empowers the central bank to “formulate and implement the exchange rate policy,” meaning that what happens in the currency markets is the responsibility of the SBP and the individuals running the organisation.

When we assess the SBP’s actions and conduct over the last few years, we find that it has, for the most part, failed in not only fulfilling its mandate, but also voluntarily ceded its independence without any overt resistance.

Anti-inflationary measures

Let’s start with the goal of achieving price stability, meaning reining in inflation. For the past few months, the central bank, through its monetary policy statements, had been painting a rosy picture about the inflationary outlook in Pakistan.

For example, in January 2020, the SBP argued that its current policy position was “appropriate to bring inflation down to the medium-term target range of 5–7 per cent over the next six to eight quarters.”

This obviously did not materialise, but the SBP kept insisting that this “medium-term target range” was achievable, arguing two years later in January 2022 that “during FY23, inflation is expected to decline toward the medium-term target range of 5-7pc more quickly than previously forecasted.”

For those who may not know, inflation in Pakistan currently stands at over 27.5pc.

Meanwhile, the SBP also kept changing its position with regards to the impact of the fiscal deficit. For example, in January 2021, it said that “the FY22 budget is expected to be broadly inflation-neutral”. But then a year later, in January 2022, it said that the mini-budget introduced by the government represented a “significant additional fiscal consolidation compared to the budget and has lowered the outlook for inflation in FY23.”

As if these moving targets were not enough, in a recent article, the former deputy governor of the central bank wrote that “the primary deficit for July-March FY22 was Rs447 billion compared to a primary surplus of Rs194 billion in the same period of the previous year.” This, according to the deputy governor, was a “significant fiscal expansion of more than 1 per cent of GDP.” But while this is being pointed out in 2023, the SBP itself told us that the budget was “broadly inflation neutral” when it was passed some time ago!

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Enter Dar

Faced with the entry of a finance minister who was keen to shout down the dollar and negotiate by looking into the IMF’s eyes, the central bank (with a more pliant governor at the helm of affairs) decided to go along for the ride by instituting measures that created a Soviet-era economy, leading to the creation of a black market for foreign currencies, especially the US dollar. The price and supply-chain distortions from this policy are still wreaking havoc across the economy, with shortages of essential items, including petrol, being reported across Pakistan.

As if this was not enough, the SBP undertook one last action to completely annihilate its own credibility: hours before the Dar Peg broke, the SBP governor went on television to insist that the market value of the dollar was around Rs230, which was the interbank rate on the day he gave the interview.

Hours later, the peg broke and the rupee was in free fall, with the market informing the governor that the actual value of the currency was closer to Rs270 to the dollar, not Rs230 as he had insisted.

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Policy failures

There are various other actions that the central bank undertook over the last few months that also deserve to be called out, including the fact that it was always behind the curve on raising the policy rate — an outcome of its insistence that the medium-term inflation target was about to be met — and on providing cheap subsidised credit to well-heeled businesses through mechanisms like TERF and housing and construction finance. The latter spurred the speculative bubble in real estate, fuelling a casino economy in unproductive assets.

And while one could argue that these were well-intentioned measures aimed at catalysing growth and minimising the fallout of the pandemic, they must be viewed within the broader context of Pakistan’s rapidly deteriorating economy and runaway inflation, which is yet to peak.

In addition, we must view these failures within the context of increased autonomy, which was rightfully provided to the SBP through what was a flawed process. Giving increased independence to the SBP was important, given how it had basically functioned as an extension of the finance ministry in the past.

Read more: The state — and the State Bank’s autonomy

With increased autonomy, the argument went, the SBP would be able to carry out its duties more effectively. In addition, this increased autonomy, given to the SBP by parliament, should also have signalled to the Ministry of Finance and other institutions that the central bank must be allowed to do its job as it sees fit.

Independence, however, is not achieved overnight or by the stroke of a pen. A key determinant of success is the institution’s own ability to assert its independence, which is dependent on individuals running the organisation.

But rather than increase its independence over time and fight for its autonomy, we must contend with an uncomfortable truth: instead of exercising its own independence and fulfilling its mandate, given to it by the people of Pakistan, the SBP has, over the past few months, become even more subservient to the whims of men running the finance ministry.

This capitulation of what was supposed to be an independent institution has inflicted unimaginable trauma on tens of millions of ordinary citizens, with countless falling below the poverty line. And all of this has happened because individuals running the SBP have continued to fail in their duty, fulfilling their mandate, and asserting the independence of their own institution.