On July 1, 1948, Pakistan’s Governor-General, Quaid-e-Azam Muhammad Ali Jinnah, ordered the State Bank of Pakistan (SBP) to regulate banknotes’ issuance and hold the foreign reserves in order to enhance monetary stability in the country. The SBP was granted the authority to guarantee financial stability and full use of the country’s economic assets. This gave Pakista independence from the Reserve Bank of India and was an important first step to secure monetary stability. However, the SBP did not enjoy total independence from the other government wings since then.
A significant improvement in the economic situation of those countries has been noticed who had given full autonomy to their central banks. Before we get into the core of the independence debate, it is important to consider the role of a central bank. The autonomy of the central bank and the independence of monetary policy are the same things expressed differently.
An autonomous institution is self-governing, and it has the ability to perform several functions without the intervention of any external authority.
Globally, the legal characteristics of independence as stated in the charter of the central bank are grouped into four segments:
• The appointment and dismissal of the central bank’s governor and other terms of office
• Policy formulation and arbitration of monetary policy issues between the executive branch and the central bank, as well as the central bank’s intervention in the budget process
• The objective(s) of the central bank
• The authority of the central bank is to impose lending restraints on the public sector.
The State Bank of Pakistan (SBP) Amendment Bill 2021 is a major bone of contention between the IMF and the Government of Pakistan. Pakistan is on its 23rd IMF program, and the IMF has yet to realize that its demands are not being completely met by Pakistan. As part of the IMF’s loan renewal, the current requirement is that the SBP should be granted autonomy.
The SBP was given autonomy in 1994 in some aspects as part of the financial sector reforms and operated under the State Bank of Pakistan Act 1956. The State Bank of Pakistan Act, 1956, the Banks Nationalization Act, 1974, and the Banking Companies Ordinance, 1962 were amended in 1997. n 2012 and 2015, more adjustments were made to make the SBP self-sufficient. None of these resulted in gaining full autonomy status for the SBP.
Following the financial problems across the world in 2008/09, central bank independence has received much interest. Central bank independence has been further enhanced by the need to avoid and minimize panics in the capital markets. Theoretically, this independence is justified on the idea that an independent central bank is a mechanism to solve the problem of temporal consistency: the only fear that policymakers, in the future, may violate a policy promise made today. Supporters of autonomy believe that it was the central bank’s innovation and effectiveness in monetary policy that helped avoid massive financial losses and economic collapse. Furthermore, they point out the global effectiveness of central bank-driven anti-inflationary programs. In both developed and developing nations, research finds a negative relation between inflation and central bank independence. In simple terms, nations with autonomous central banks have lower inflation than ones without such independence. The autonomy granted to SBP would free it from political interferences and pressures that the central bank has faced throughout its existence.
In developing countries, the situation becomes more challenging, where the central bank’s job involves numerous objectives in addition to price stability, such as growth, employment, and financial inclusion. The favorable way to achieve these objectives for the federal, provincial, and municipal governments, as well as the central banks, is to work collaboratively. As a result, coordination of fiscal and monetary policy becomes crucial in obtaining the expected objectives. Therefore, it is a preferred strategy to design a structure in which the central bank is not just independent of the government but also autonomous within itself. This signifies that elected political representatives set aims for economic growth, inflation, unemployment, and other economic factors in consultation with the central bank, but the latter retains operational autonomy and the liberty to choose the relevant tools to meet certain requirements, especially in the areas of inflation, exchange rates, rate of interest and so on.
The proposed SBP independent act would boost the efficiency of the central bank’s operations and strengthen its governance. It will allow the bank to appoint its director and Members of the monetary policy according to its own will. The independence will result in the bank working not to meet the political agenda of the current regime enforced through the Ministry of Finance.
Thus, there is a fundamental contradiction between policy efficiency and policymakers’ legitimacy. The unpleasant tension that pervades interactions between Finance Ministers and Central Banks throughout the world is a symptom of this struggle. Economic policies have distributional effects, with winners and losers, and elected politicians want to make sure that their followers and constituencies, while the central bank wants to make sure that the advantages and losses are distributed evenly across the world.
Those who oppose autonomy are worried about the legitimacy of decisions made by a panel of technical experts who are not elected. Consumers, producers, investors, businesses, and families are all impacted differently by the policies of the central bank. They can`t hold central bankers liable for their actions. As a result, central banks dominated by technocrats lack political legitimacy in their actions.
The SBP Act would save the country from the spending spree typical of a political regime reaching its end of tenure. Such spending sprees are inflationary and hinder the central’s bank price stability function. Given the IMF’s demand for independence to the SBP, especially now that the loan disbursements are contingent upon prior actions, it would not be a bad idea to embrace the SBP act in its current form.