Global Village Space recently interviewed Mr. Shahid Hafeez Kardar to get a basic understanding of the recent State Bank of Pakistan Amendment Act 2021.
Mr. Kardar is a Pakistani economist and former provincial finance minister. He served as the 16th Governor of the State Bank of Pakistan from September 2010 to July 2011. He is currently serving as the Vice-Chancellor of Beaconhouse National University in Lahore.
Since it first leaked to the public last week, the news of a proposed amendment in the central bank’s status has become a topic of national discussion. Some people have gone so far as to call it an IMF conspiracy to break Pakistan while others thought it was against our national interest.
The draft bill, the SBP Amendment Act 2021, has been passed by the National Assembly and is currently being discussed in parliament. It is open for debate and hasn’t yet become law. It will be up to parliament to strike it down, make changes to the draft or approve it as proposed.
The former governor of the State Bank explains the amendment in detail and talks about the controversies surrounding it.
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GVS: Can you explain why the SBP Amendment Act 2021 has become so controversial? It is being cited as the reason why Dr. Hafeez Shaikh may have been removed from the Finance Ministry.
Shahid Kardar: I am not aware of the latter, but it’s odd in a sense that if that was one of the reasons, I can’t imagine this law would have been tabled to Parliament had the Prime Minister not been briefed, unless he never understood it, which I suspect is not the case, but maybe because the reaction has been so strong for a variety of reasons.
Let me try to put it as simply as I can. There is general support for greater autonomy. The issue could be the nature and the extent of this autonomy, but we don’t have the actual bill in front of us.
GVS: Exactly, why haven’t they put it in front of the public yet – why are they hiding it?
Shahid Kardar: Anyone in this country would want a debate on this, but what we have is a very strange situation, and the State Bank itself is complaining about people commenting and giving their views without having read the Act. So please make it available for us!
On the one hand, you’re complaining, on the other hand, you don’t want transparency. Surely, that is not the way to proceed. We all want to have a genuine debate to try and achieve similar objectives towards greater autonomy.
The reason why it is also important in one way is that the old Act [1956], which was made for a different era, still has a bit of fuzziness and lack of clarity about the functions and the accountability mechanisms, although there have been changes since the 1990s.2
So setting out these objectives and functions much more clearly, certainly is a step in the right direction, logically and legitimately, since there is a fair amount of redundancies with the existing Act in terms of both policies and the actual instruments. The negative reaction by commentators has been much more on the accountability part.
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GVS: Looking at the current suggested Act, two things are being mentioned; one is that price stability is our number one focus, the second objective will be to keep an eye on the financial system, and the tertiary objective is economic growth. Are these new objectives, or were these already in the pre-existing law?
Shahid Kardar: Yes, they were! And I challenge anyone who says to me that over the last 25 years, the State Bank had problems implementing their monetary policies, exchange rate policies, or managing the stability of the financial system. I challenge anyone to say this.
So in a sense, what you and I would call an intervention- the de facto autonomy part, which is supposedly weak-I ask you a much simpler question; the same institution raised the interest rates to say 13.25% using the same law, right? Was there a problem? No. Financial stability of the system, has there been a problem? No.
Looking at the exchange rate management – this had two variants, which I would refer to as one, there were long periods in which the institution itself, without undue pressure from Islamabad – managed to maintain a certain level of the exchange rate, which I would prefer to call ‘lower-valued exchange rate,’
Secondly, perhaps they were decision-makers in particular governments-no names mentioned- who were in one way or the other transferring funds abroad. It became easier to have an overvalued rupee to get a better rate – but these were fewer cases than the first scenario.
So, if we are going to do something with the Act, let us look back and ask ourselves, should we continue to perform the same functions and objectives?
Because the 1956 Act, when it was amended significantly in the nineties, had the objectives and functions put into the Act reflecting the economic structure of that time.
The country has changed. Now there are conflicts in both objectives and functions, which to my mind, is the perfect opportunity to examine and decide whether it should continue to do what it has been doing in the past.
GVS: In terms of economic growth, are you worried by the fact that this is now considered a tertiary objective, or do you think it’s no different from the existing law?
Shahid Kardar: Yes, now in a sense, if they start saying that this area is of very little concern to us, then I am obviously and seriously worried. So that’s why it’s important that we need to be very clear.
Even if you look at a country like the US, the Federal Reserve has employment as an objective as well.
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GVS: But many other countries in the world don’t, right? Even though they don’t have official employment or growth objectives, when something like Corona happened, they still did quantitative easing to help growth.
Shahid Kardar: I agree. Even when it comes to the Federal Reserves, that’s the reality. A developing country cannot afford not to have that at all. That is why I am saying it’s important to have a close liaison of the SBP with the economic policies of the government.
The monetary and fiscal coordination board should meet regularly so that there is better coordination in terms of policies and instruments, hopefully going forward.
GVS: If the State Bank will no longer fund government borrowing as is being suggested under the 2021 Amendment Act, as a developing country, we already have a fiscal deficit, how will the government then finance its development funding?
Shahid Kardar: My personal feeling is that they will continue to provide this money indirectly through the injections. I can’t believe they will one day just stop that. They will continue to provide money indirectly, at least in the foreseeable future. I don’t think anything is going to change dramatically because they will continue to help and provide money.
What the monetary policy essentially is today is to find the money for the government, somehow. And unfortunately, I can’t see how that can change. The political economy won’t let it. So they can continue to say they have the power to do so, but de facto, there is no chance.
GVS: If you say indirectly the State Bank will continue to fund the government expenditure, does that mean we don’t need to worry about the fact that the economic growth has now become the tertiary objective of the State Bank?
Shahid Kardar: In a sense, but that is not what the law says. It essentially says that is not our concern. All I am saying is we need to have a formal mechanism where we can have a macroeconomic model or a macroeconomic understanding of the balance and what needs to be done.
If things are going to happen indirectly, then that is another matter altogether. When you look at the State Bank’s objective, to achieve and maintain domestic price stability, I don’t know what it means actually because one’s man’s price stability is another man’s inflation.
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GVS: When we say price stability, are they going to specify what they are going to set?
Shahid Kardar: That is precisely the point. Say they decided 5-7% should they have the power to decide that, or should someone else consider that as a target?
There is also a trade-off between growth and inflation. I mean, we would rather have a growth rate that is at least 6 -7 percent of GDP. We need growth rates of that level, and if it means having a slightly higher rate of inflation, then we can live with it and remind ourselves we never had as high rates of inflation as Venezuela, Argentina, Sudan, or Zimbabwe, etc.
GVS: If we have never had high rates of inflation, but we have had high rates of interest. In the last two years, the State Bank raised its interest rate from 6% to 13%, and no government stopped the State Bank, so why do we need an independent State Bank?
Shahid Kardar: All I am saying is the existing laws and institutional structure has not stopped SBP from carrying out these functions and fulfilling these objectives.
Inflation in this country is not as simple a phenomenon as people try and make it out. Let me try and illustrate this very quickly. The State Bank has chosen the CPI as something they want to track and take decisions on that basis. 58% of the weight in the CPI is that of food and energy.
Food prices depend on supply issues, maybe for purely seasonal reasons and supply disruptions, for a variety of reasons. Energy prices are fixed by someone else, so what control does the State Bank have over that? So that’s one part.
Then, of course, prices would change because of imported inflation; for example, oil prices go up. That’s the supply part of issues, and the State Bank has no control whatsoever.
Then you come on the demand side. I gave you the example of the government expenditures, which are really large, and frankly, inflexible in the short term. Second, demand for goods and services is created by two other factors, which the State Bank, when it revises the interest rate, will not make any impact.
Let me give you two very quick examples; the informal sector is partly reflected through currency in circulation. 6.7 trillion currency is in circulation, and that’s 14.5% of GDP. Remittances that create demand have nothing to do with interest rates, and that is roughly 8.4% of GDP, totaling around 23%. Neither will be affected by the SBP interest rate changes.
Then, if you look at the kind of support we get through multilateral donor assistance. That money comes in two forms; one where it says ‘thou shall spend the money’ and we will reimburse it, so in other words, we can only use the money if we spend it first. That again creates a demand.
Secondly, and more importantly, they will turn around and say we will give you a project loan but a project loan from us for you to use some of our money. You must also have a counterpart rupee. So if it is a project of 100 rupees, 30% is coming from the bank, 70% will have to come from us or the other way round.
Remember, demand created by the private sector is very limited. Barely 25% of bank borrowing is by the private sector today. So who is creating the demand? The demand is being created by the government, the inflexibility of expenditure, and most importantly, the fastest growing element is the interest.
So in a sense, even when it comes to the demand side, I do not know to what extent you could actually control the demand because much of the demand is being created either externally or beyond the scope of the State Bank or by government expenditures.
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GVS: Would you, therefore, suggest that the inflation target of the State Bank should have certain components to it and maybe different, in terms of targets, from the general CPI?
Shahid Kardar: Yes, I will give you an example. You decide to raise interest rates because you think that somehow you will be able to control the demand side. However, once you have raised the interest rates, you end up, to some extent, overvaluing your rupees. All these things are inter-connected. It’s not that simple.
And frankly, we really cannot compromise growth and employment prospects by giving powers to one institution which will not be accountable to the rest of the government on a very sensitive matter.
You mentioned, and rightly, what are the parameters? More importantly, how do we judge the performance? In my opinion, we should have parameters in criteria for judging performance on the monetary policy side and also for the financial stability side. So we have parameters that they can be held accountable based on that criteria and not just saying, ‘oh, you never met the inflation target!’
GVS: What kind of accountability do you have in mind? Is this sufficient as is suggested that the Governor of State Bank will go to Parliament once a year to tell them what he’s done? Also, under the Amendment, it says that SBP officials are not to be quizzed by FIA/NAB?
Shahid Kardar: Frankly, I would start with the appointment of the governor; it should be ratified by the Parliament. The ideal location should be the Parliamentary Finance Committee, and of course, if they want to induct professionals into this process, then, by all means, they should.
Not only that, more importantly, it should not be just once a year. It should be twice a year and should be a public hearing. At the moment, the accountability mechanism is confined to the Central Bank Board.
The problem with that is that we have a situation where someone is being appointed by another party, being accountable to the Central Bank Board, and the board will decide in terms of employment, and so on, but do they have powers to reprimand?
And even if they do, let’s assume they manage to conclude that the State Bank has not achieved its objectives, will the minutes of the board be in the public domain? You and I both know they won’t. So in a sense, the mechanism of being accountable has to be to some other authority.
If you ask any institution to amend a law, now if I were to be there, what would I do? I would first protect my turf, right? Not make changes that make my position vulnerable in any way. That’s understandable, and that’s how any institution would do that.
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GVS: Which authority do you suggest?
Shahid Kardar: I would say Parliament, the Finance Committee, obviously can induct experts to help them in the questioning and quizzing of the representatives of the Central Bank and have a public hearing. Why not?
Going to NAB. That is another classic example. We all know that everyone is generally critical of the way NAB and FIA operate and the harassment and so on, but no institution can be above the laws of the country. It can’t be.
I mean, even the Prime Minister is accountable to someone. I’m not defending NAB and FIA; all I am saying is yes, we need to restructure and make the institutions more competent and accountable, so on.
GVS: In terms of the tenure of the State Bank governor, apparently they’ve extended it from 3 years to 5 years, and he can be re-appointed as well.
Shahid Kardar: I think it should be one term because then there would be a temptation to please the government if you want the second term. I mean, yes, agreed, 5 years. That will, to some extent, enable continuity while there is a change of government. Certainly not another term, one tenure for 5 years is more than enough.
GVS: From everything that I have heard you say, it seems to suggest that currently, the State Bank can more or less do everything in terms of controlling inflation. The IMF has suggested the State Bank autonomy under several programs that Pakistan has done, it’s not the first time it has mentioned this. So then why are we now thinking at this stage of going ahead with the autonomy when we haven’t in the past?
Shahid Kardar: I don’t know what the answer is to that. All I am saying is de jure even today; there is no problem. The problem is the de-facto part, the de-facto autonomy. That’s where the real problem is, and frankly, I can’t see it changing. Fundamentally it is not going to change.
So when the government wants to intervene, make life difficult for the institution, it can do so. It will depend on the mindset of the key decision-makers of the government of the time.
I am still not sure what they think ‘autonomy’ actually means. Someone should set the targets, hold them accountable, even set the parameters and criteria, so it’s a fair assessment of performance.
You can’t have the State Bank Board doing this itself, given the nominees on the board will be appointed by the government from the list of candidates provided by the State Bank itself.
GVS: What I am gathering from you is that the State Bank is involved in too many things where it comes to monitoring itself. So these are the things which the government needs to be looking at and ultimately questioning why we have allowed the State Bank to make this law in the first place.
Shahid Kardar: I would just add one more thing, we need to have better coordination on economic policies with the government, and I genuinely believe the Monetary and Fiscal Coordination Board should not be done away with as is being suggested.
They are saying that we will have a close liaison between the governor and the finance minister, but what does it mean? There are no formal institutions for that. Does it mean they both will be on WhatsApp? Does it mean that every time I am in Islamabad, I will call on him, or if the finance minister is in Karachi, he can come and see me, and we can have a chat over a cup of tea?
No. The procedure behind what constitutes liaison should be formally incorporated into the law. And it should be collective wisdom, with all trying to achieve the same objectives so that we are all heading in the same direction.
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GVS: So overall, you want the State Bank autonomy law to go through. Is that what you’re recommending?
Shahid Kardar: I would strongly support operational autonomy for the State Bank when it comes to administrative matters, on its regulatory functions and policy measures and instruments it adopts for achieving the inflation-related targets set in consultation with the government.
And in my opinion, much of this operational autonomy is already available to it. In the law that has been tabled, the only thing that I would propose concerning the decisions of the monetary policy committee (equipped with the requisite skill mix, expertise, and experience) would be that it should report to the Central Bank Board.
This would be like the Economic Coordination Committee of the Cabinet (ECC) providing inputs on a variety of economic matters to the Cabinet for its deliberations and final decision. After all, the board should be the ultimate authority on all matters mandated to the State Bank.