Pakistan News Service

Thursday Feb 22, 2024, Shaban 12, 1445 Hijri

The SBP Governor`s exit

20 July, 2011

By Dr Maleeha Lodhi

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The resignation of Shahid Kardar as Governor of the State Bank came as little surprise. It would have been hard if not impossible for a respected professional like him to continue in the face of executive interference in the central bank’s operation. He therefore followed the only course open to him by stepping down from this position.

In a statement accompanying his terse resignation letter the reasons he cited have laid bare the policy differences that obliged him to part ways with the government. He referred to government directives that in his judgment were inconsistent with the integrity of the Bank. He also cited “critical differences” that impeded the fulfillment of the Bank’s mandate to “ensure the prudent conduct of monetary policy” and “maintain the safety, soundness and stability of the banking system”.

Mr Kardar’s departure is a blow to the credibility of the government and will further erode confidence in its ability to manage the economy at a time of great financial stress and challenge. The shortness of his tenure – nine months – is a measure of the extent to which economic decision-making has become politicised. His exit will potentially weaken an institution that had emerged as an example of effective economic governance.

Mr Kardar’s resignation injects more uncertainty into the economic outlook already undermined by low growth and high inflation – the latter fuelled by high government borrowing from the central bank. The circumstances of his resignation will make it hard to recruit a credible replacement. However ironic, the only way for the government to mitigate the negative fallout will be to quickly find just such a successor.

This unfortunate episode nevertheless underscores the criticality of the state bank’s independence and autonomy for sound management of the long stricken economy. It also shines a light on the mandate Mr Kardar was responsible to protect, but says he was unable to do so without contributing to a “deadlock in economic decision-making”.

To understand the role and responsibilities of the central bank governor it is important to recall the historical and legal background and context. The State Bank of Pakistan (SBP) had no legal powers to function as an independent central bank until banking sector reforms instituted in three installments in 1993, 1994 and 1997 by the interim administration of Moeen Qureshi and the governments of Benazir Bhutto and Mian Nawaz Sharif. Prior to the 1993-97 reforms the SBP governor and board of directors could be appointed and removed at will by the government. Staffing and policy decisions could not be taken by the SBP without the approval of the Finance Ministry

Federal and provincial governments could borrow any amount from the Bank or commercial banks with no regard for its implications for inflation and effect on private sector development. Credit policy for the private sector was subject to approval by the finance ministry and no major governance decisions could be implemented without Islamabad’s prior consent. The SBP could not even issue its Annual Report without the government’s clearance.

Such had been the pernicious consequence of the nationalisation of banks in 1974 and establishment of the Pakistan Banking Council under the administrative control of the finance ministry that even the sanctioning, regulation and supervision of commercial banks was in effect taken away from the State Bank. Commercial banks began to operate under the direct control of the ministry of finance. This reduced the central bank to a handmaiden of the government; monetary policy too became a hostage to the fiscal whims of the finance ministry.

This was to change by the legislative reforms introduced in the banking sector during 1993-97. They transformed the legal framework for the SBP’s operation and that of the finance ministry as well as their relationship.

The most relevant legal provisions of the 1993-97 reforms were:

(1) The bank governor and board of directors, once appointed, could not be removed before the end of their tenure except if they were unable to function for physical or mental reasons or were guilty of “breach of trust”, and that too under a due process defined in the State Bank of Pakistan Act.

(2) The decision of the board of directors taken by majority vote was to be final and binding without the involvement of the finance ministry. But its secretary as a board member could present the ministry’s views.

(3) The central bank acquired the sole authority to sanction, regulate and liquidate a scheduled bank with the abolition of the banking council.

(4) No government or quasi-government body could issue any direct or indirect directives to any bank or financial institution regulated by the SBP.

(5) Only the SBP could “determine and enforce” the credit limit it could extend to any government or official agency.

The fifth provision was particularly important in the framing of prudent monetary policy consistent with the economic objective of ensuring relative price stability. Only the central bank could decide the level of government borrowing on monetary policy considerations keeping in view the inflation target, the private sector’s credit requirements and anticipated changes in the country’s foreign exchange reserves position. Bank borrowing dictated by the budget’s financing requirement could thus conflict with the law, compromise the autonomy of the SBP in the conduct of monetary policy and of course fuel high inflation.

Anticipating the need for coordination of fiscal and monetary policies without interference in each other’s domain, the SBP Act has a mandatory provision of regular meetings of the Monetary and Fiscal Policies Coordination Board (MFPCB). However, it has an explicit provision that in fulfilling this coordination mandate, the Board would “not take any decisions that would adversely affect the autonomy of the State Bank of Pakistan”. The law gave no power to Islamabad to dictate the amount of government borrowing from the SBP and influence formulation and implementation of monetary policy, which is the central bank’s exclusive jurisdiction.

This statutory framework enabled the SBP to operate as an autonomous institution even if there have been several tests of wills between more independent-minded governors and governments at different times since the mid 1990s. But it is also true that the gap between the law and practice has widened over time because of the increasing unwillingness of the government to abide by these rules or weaknesses shown by some governors to protect and defend the bank’s integrity and autonomy.

It is reportedly because of Mr Kardar’s resolve to work within the legal framework and his reluctance to implement government directives contrary to the provisions of this framework that he reached a point where he was constrained to step down.

But the country’s economic problems are not going to go away or become easy with his departure. If anything, economic prospects are clouded even more by issues at the heart of ‘policy differences’ that resulted in a premature end to his tenure.

His departure in the presence of a clear legal framework for government conduct in relation to the banking system leaves the dilemma unresolved. A pliant new governor who does not protect the autonomy of the SBP, as enshrined in its charter, and follows executive directives with regard to borrowing, credit to the private sector or oversight of banks will be doing a national disservice and also acting contrary to his legal responsibilities. Moreover, the SBP will fail to achieve its prime objectives of ensuring sound banking practices and relative price stability.

The government will be better off putting its fiscal house in order rather than make the SBP subservient to its financing and other requirements including considerations of political patronage – all of which are a violation of the law.

Courtesy: The News

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