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Banking on Trouble

One of the most important Ordinances enacted by the Moeen Qureshi Caretaker Administration was the State Bank of Pakistan (SBP) Ordinance of October 1993. This gave virtual autonomy to the SBP thereby separating the governance of fiscal and monetary policies. This Ordinance was due to expire on Feb 5, 1994 if it was not passed by the NA or the Senate but it was repealed on Jan 1, 1994 and replaced with another which has considerably curtailed the independent status of the SBP. To understand the intricacies of the how and what for, one must come to layman’s terms with certain economic facts that govern fiscal and monetary policies and the mutual relationship thereof.

Market oriented economies have three principal objectives, viz. (1) economic growth (2) financial stability and (3) viability of external sector of the economy. While economic growth is self-explanatory, financial stability requires price stabilization, maintenance of people’s confidence in the currency of the country and the viability of financial institutions while persevering with consistency in financial policies. To maintain the viability of external sector of the economy there should not be a unsustainable large balance of payments deficit and that automatic inflows over the mid-term period should take care of balance of payments problems. To achieve these three micro-economic objectives there are two sets of approaches, viz. (1), market oriented and (2) centrally planned, centrally directed approach i.e. State ownership, complete regulation and direction, etc.

Assuming we have discarded the decades old centralized approach and that we are headed towards economic management in which price mechanism and private initiative will play the decisive role, both in resource mobilization and resource allocation, the option being a market oriented approach. Then for the three objectives aforementioned, there are three policy instruments which have to be exercised, chased and coordinated. These instruments are fiscal policy, monetary policy and exchange rate policy. All three policies cannot be handled exclusively by the Government as this will amount to the same thing as centrally directing the economy. At the same time there is no exclusive domain for each of these policies. Monetary policy cannot be thought of without considering the dimensions of fiscal policies and targeted exchange rate, same is true of other true instruments. The most crucial area in fact, is the appropriate and timely coordination between the three policies to achieve the micro-economic objectives as decided by the Government in consultation with the concerned economic agencies at the beginning of the year. For example, the growth rate has to be decided on the estimates of resources available, monetary policy on basis of economic growth and the permissible increase in prices while exchange rate will essentially emerge from actual operations of monetary and fiscal policy as well as developments abroad. If both these factors are sound, price increase will be manageable and its impact on the exchange rate minimal. In this connection all three policies have to be coordinated on a continued basis.

All this leads to the US$ 64000 question, the independence of the Central Bank. This can be reflected by a number of indicators i.e. the legal framework, rate of inflation, frequency of change of Central Bank Governors and lastly interdependence between the last two indicators. The options available are, firstly, complete independence but accountable to Parliament only. In this respect the necessary factors are a mature Central Bank, mature Parliament, mature Ministry of Finance, mature Government, etc. This model is certainly not available in any developing country and only developed countries such as Australia, New Zealand and West Germany follow this route. The second option is the complete subordination to the Government i.e. the Central Bank should become a technical Wing of the Ministry of Finance, most developing countries followed this model. Lastly, there is the third option of a working relationship between the Government and the Central Bank where a degree of independence is given to the Central Bank who will generally frame their evaluations after analysing various factors i.e. the policy package given to the government by bureaucrats, the economic programme of the Party in power and the economic suggestions of the Opposition. In this option, the Central Bank gives a good analysis of the policy options but the final authority still rests with the Government in power. Government can decide about variables and objectives but not all of them, for instance they can decide about the growth rate and target the increase in prices but it cannot also decide the rate of monetary expansion. Given the growth rate and expected increase in monetary supply, the Central Bank should be left relatively free to decide the quantum of monetary expansion. Fiscal and the monetary policies are separate but the government still has the final authority to overrule the advice of the Central Bank.

Given this background, one can understand the changes affected by the Moeen Qureshi Caretaker Administration in the State Bank of Pakistan Act of 1956 vide Presidential Ordinance 28 of Oct 5, 1993. In summary, the SBP became more autonomous and the Governor relatively independent of the Government as was the requirement for separating monetary from fiscal policy. Central to this was the appointment of a Governor for a term of five years without eligibility of re-appointment. In practice this meant that the SBP Governor was not inclined either to curry favour with the government in power or look over his shoulder for continued employment beyond his term of office. As such was not susceptible to being beholden to anybody. Removed from the shackles of the Ministry of Finance, SBP could exercise greater monitoring of the financial institutions, some of whom had run riot over the years being directly influenced by the bureaucracy and later by a combination of politicians and bureaucrats. More importantly, SBP could for the first time check the prolifigerate ways of the Federal and Provincial Governments in living much beyond their means on extended overdrafts. Over the past 4 years, borrowing by the Government has far exceeded the limits going up to an embarrassing Rs.70.3 billion in 1991-1992. Monetary expansion has to be kept at 14.5% to maintain inflation at 8%. At the rate of borrowing in 1991-1992, the expansion went upto 29.6%, nearly double the safe limits. If Government borrowing from the banking system exceeds the Rs.20 billion limit presently indicated, it will mean currency notes will have to be printed beyond the parameters indicated. Revenues are in short supply while the demand for money continues to grow, this has placed SBP and successive Governments in an embarrassing position.

The real mystery is why the Ms Benazir regime did not wait for the SBP Ordinance to die a natural death on Feb 5 due to legislative inaction. If the reasoning was that by letting the Ordinance lapse they would have offended the World Bank and the IMF which were very much in favour of the October Amendments, the PPP Government has succeeded in arousing their anger anyway. Somehow one feels that there was no real reason to jump the gun as it has hurt the government politically internally and externally without adequate and defined benefits. A part of this gaffe may have been caused by bureaucratic skullduggery Dr Yaqoob, SBP Governor, was appointed by the Nawaz Sharif Regime and was confirmed by the Moeen Qureshi Administration. This did not set well with the bureaucracy who see him essentially as an outsider. Having a brilliant Punjab University Academic record, Dr Yaqoob joined SBP in 1960 and after educational studies in Yale (for his MA) and Princeton 1964-66 (for his Ph.D.), he rose upto the rank of Director of Research of SBP which he remained from 1966-1972. In 1972 he joined the World Bank as a Junior Economist rising first to Assistant Director and then Division Chief in the shortest possible time. In 1992 he resigned from the IMF because of policy differences with the management. Returning to Pakistan, he was offered the job of Special Secretary Finance which he remained till being elevated as Governor SBP. Belonging to a poor family settled in Faisalabad after migrating from Jullunder, Dr Yaqoob represents the merit standard of free enterprise, having risen to his post not due to nepotism and favouritism but due to the dint of sheer merit. A man of known integrity, he is extremely forthright and explicit in his views. He brings a great strength to the institution of SBP. Dr Yaqoob is a great choice by any standards but naturally has detractors among frustrated aspirants among the bureaucracy and within the SBP, particularly those who were led (or tended) to believe that the job was theirs for the asking.

The Moeen Qureshi Administration seriously erred in their choice of Directors in not having anyone from the interior of Sindh or from the Agriculture sector. Furthermore, Syed Babar Ali could have avoided charges of nepotism by not nominating relation Yawar Ali or Academic Wasim Azhar from his Academic institution LUMS. This served to besmirch the actual need for the changes effected as they seemed to be done by deliberate design. With the SBP Governor independent of the bureaucracy, the new PPP Government must have found itself in a financial straitjacket even to meet administrative expenses or the spreading of largesse to keep Parliamentarians in line. While at best it is a conjecture, one assumes that the actions of the present Government in repealing the Caretaker-inspired Ordinance has neatly dovetailed the different motivations of various interested parties, particularly the bureaucracy which takes revenge in the only way it knows, manipulation of laws to wipe out its opposition.

The most significant aspect is the shortening of the term of the Governor to 3 years and making the appointee eligible for another term of 3 years. Clearly this is meant to erode his independence and keep a Sword of Damocles over his head. To compound this further the Government has the right to reconstitute the appointment of the Governor and the Board of Directors within 180 days. It is a fair bet that this implies that either the SBP Governor and the Board comes into line and plays ball or else faces the axe. It also implies that the Government may be trying to move a more pliable person in place. Market rumours seem to indicate that these are preliminary moves to a takeover bid which will be made for any one of the remaining nationalised commercial banks or their subsidiaries, e.g. Habib Credit and Exchange Bank Limited (old BCCI). A friendly SBP Governor and Board will then become extremely useful. As such the assumptions of knowledgeable circles is that bad faith is manifest in the new Ordinance. Whether this is justified or not only time (and the subsequent actions of the Ms Benazir Government) will prove.

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