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Letting the fox Guard the Chicken Coop

Moazam Mahmood
Lahore School of Economics

The proposed legislation on the functioning of the State Bank of Pakistan being reported in the public press is extremely controversial. Deserving of a debate. Rather than a railroading, on pain of being unable to rejoin the IMF $6 billion loan EFF/SBA funding facility which was discontinued a year ago with the advent of the Covid pandemic.

Consider the pros and cons, so even a banker can understand.

Pro one: The autonomy of the SBP is a good, much to be desired, for professional management of the economy.

Con one: Undoubtedly. But there are reports that this management of the economy is to be reduced from the classic dual function of

(a) Generating growth and full employment, and
b) Managing inflation. (In a tradeoff with the budget deficit).
To just b) Managing inflation

The two functions are a good. And give the SBP a responsibility to balance growth against inflation. Jettisoning growth, will make the SBP just managers of inflation, with no responsibility or accountability for growth.

Con two: Why is the IMF insisting on this jettisoning of the responsibility for the mandate for growth? Most advanced economies and developing countries give this mandate to their State Banks.

The SBP controls monetary policy, by setting the interest rate. This a major policy instrument to generate growth. Especially in a time of crisis like the present crisis in growth. Why are we tying one hand behind our back in combatting this crisis.

Christine Lagarde in her previous job running the IMF was lauding state banks’ use of monetary policy to generate growth under the financial crisis. Her successor still does. Why then is the IMF pushing the SBP to abandon the use of monetary policy for growth in the present contraction in Pakistan.

Pro two: Monetary policy should not be used to generate growth. Just to manage inflation, ever threatening to double digit in Pakistan. Which would hurt the poor far more than the rich.

So the SBP will only use the interest rate to control inflation. And adjust the money supply to set the interest rate. The policy instruments used will then be to raise the interest rate, by reducing the money supply.

Con three: Raising the interest rate will kill off more investment and growth than the Ministry of Finance can generate through its incentive schemes.

Pro three: Tighter autonomous control over money supply by the SBP, to control inflation, will also prevent GOP from using the SBP to fund runaway expenditure.

Very desirable and laudable safeguards against politicians using government expenditure to finance their re elections, corruption, and nepotism.

Con four: But if monetary policy can no longer be used to generate growth, then GOP will have to use fiscal policy to generate growth. Which will entail higher fiscal expenditures.

But wasn’t that what the new SBP mandate for just using monetary policy for controlling inflation was supposed to prevent in the first place.

Pro four: Okay we wont get growth out of this new dispensation for the SBP. But we will jolly well control inflation.

Con five: Is the current inflation of 8% to 9% demand driven or supply driven.

It cant be demand driven. With the current crisis, employment, incomes and demand are down.

Then its supply driven. With rising costs of production.

What’s raising the cost of production? Cant be the wage rate, which is languishing with high unemployment and lockdowns.

Then what’s raising the cost of production is the depreciating exchange rate. With much of energy imported, plus a lot of plant and equipment, the depreciating of the exchange rate has raised the cost of production, passed on to consumers as inflation.

Pro five: But we’ve finally got a market determined exchange rate. This will prevent over appreciation of the Rupee. The big depreciation we have seen as a result of the float under the IMF agreement, will fix our Current Account deficit. The depreciated exchange rate will raise exports. And lower imports.

Con six: Last we heard, net exports, exports minus imports, generate growth. Surely not the SBPs mandate for long. Just inflation.

So the SBPs new mandate is to be, to manage inflation. And a major policy instrument to control inflation is the exchange rate. But currently the exchange rate is causing this inflation in the first place.

Leaving a hapless GOP trying to desperately control prices by fiat in bazaars. While its own autonomous SBP is causing this inflation in the first place.
Isn’t that really allowing the fox to guard the chicken coop.

Pro six: I honestly believe, as does much of the country, that the present Governor of the SBP is an honorable man. Extremely capable of handling his institutional autonomy. And needs to be protected from lawsuits that might interfere with his autonomy of decision making.

Con seven: Reza Baqir is an honourable man, like Brutus. But a few governors ago, his incumbents ran $10 billion of SBP reserves into the ground. During the Asian Crisis, the Governor of the Royal Bank of Thailand was made liable for squandering far fewer billions.

May God give Reza Baqir a long life and incumbency Mashallah. But apres cest la deluge.

A general policy caveat: Interest rate, prices and exchange rates, are best fixed through coordination in as many markets. For money, goods markets, and tradeables, respectively. Policy for growth and prices has to be worked out simultaneously across GOP. Not by a compartmentalization of functions between the Ministry of Finance and the SBP. Its called general equilibrium. Time we learnt it. And cited the parable back to the IMF.

Link to the Article in the Express Tribune


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