Average is not over: Objectives of SBP
It is a shame that in a period of 10 months, the top technocratic minds of SBP, MoF and IMF can't get the first paragraph of the SBP Amendment Bill right.
Once more unto the breach, dear friends, once more;
— William Shakespeare (Henry V, Act III, Scene I)
If that’s your best, your best won’t do
— Twisted Sister
I had promised myself that I won’t write another post on the SBP Amendment Bill, but since the bill hasn’t been passed in the senate yet, I decide to redo the post one more time. Fingers crossed that this is the last post on this topic.
The post is focused on the objective section of SBP. It is divided into three sections for easy navigation. The first section just presents the objective section of the current act and the revised bill. The second section is short - comparing the two versions. And finally, the third section goes over the new objectives in detail.
Section 1
The SBP Act 1956 in its most current form does not have an objective section, only a preamble that acts instead of the objective section. One of the major amendments introduced in the State Bank of Pakistan (Amendment) Bill 2021 is the introduction of the Objectives section and modification of the preamble to be in line with the objectives.
SBP Act 1956 (as it exists now)
Preamble
WHEREAS it is necessary to provide for the constitution of a State Bank to regulate the monetary and credit system of Pakistan and to foster its growth in the best national interest with a view to securing monetary stability and fuller utilisation of the country’s productive resources;
SBP (Amendment) Bill 2021
Section 4B is inserted in the Act defining the objectives of SBP. The Act opens with a preamble, so the objectives must be based on the preamble. However, I believe, the drafting team first came up with the objectives and then amended the preamble to match the objectives. There may be constitutional or legal reasons for keeping both the objective and the preamble, but personally, I believe, the Act should have only one, either the objective or the preamble.
Objectives
In the said Act, ….the following new sections .. 4B … shall be inserted, namely:-
4B. Objectives.- (1) The primary objective of the Bank shall be to achieve and maintain domestic price stability.
(2) Without prejudice to the Bank's primary objective, the Bank shall contribute to the stability of the financial system of Pakistan.
(3) Subject to sub-sections (1) and (2), the Bank shall support the Government’s general economic policies with a view to contributing to fostering the development and fuller utilization of Pakistan's productive resources.
Preamble
The existing preamble is replaced with a new preamble.
….. for the preamble, the following shall be substituted, namely:-
"WHEREAS it is necessary to provide for the constitution of State Bank to achieve domestic price stability by way of regulating the monetary and credit system of Pakistan and, without prejudice to said primary objective, contribute to the stability of the financial system of Pakistan and supporting the general economic policies of the Federal Government to foster development and fuller utilization of the country's productive resources;".
Section 2
Comparison of the preambles
Below is the comparison of the preamble between the original as it exists now and revised as per the new bill.
The text highlighted in yellow is the one deleted from SBP Act 1956 and the underlined one is the inserted text as per the SBP Amendment Bill.
Five major changes are taking place in the preamble:
INSERTION: "domestic price stability" as the primary objective
INSERTION: "stability of financial system" as secondary objective but "without prejudice to said primary objective"
DELETION: "foster growth in the best national interest"
INSERTION: "supporting general economic policies of Federal Government to foster development"
REPLACEMENT: British spelling of "utilisation" with American spelling of "utilization."
Section 3 - The Analysis
1. Primary Objective
The primary objective of SBP is to achieve domestic price stability. Earlier in the bill, price stability is defined as
"price stability" means the maintenance of low and stable inflation guided by the government's medium term target inflation.
Thus, the primary objective of SBP is
achievement and maintenance of low and stable inflation guided by the government's medium term target inflation.
I have raised these questions earlier, but these bear repeating one more time.
What exactly is "low and stable inflation"?
Which inflation metric will be used. Core, CPI, SPI, wholesale, etc.?
How and when will the "government's medium-term target inflation" be set and communicated?
Who is referred to as “government” in the above phrase/objective?
What is the "medium-term"?
How will the SBP be held accountable when the key terms of the objective mentioned above haven’t been defined or no mechanism has been written down on how these terms will be defined?
The above primary objective description is what is typically called inflation targeting. Let’s see how New Zealand, the birthplace of inflation targeting, manages this regime. From a speech by Assistant Governor of Reserve Bank of New Zealand
To give greater specificity to the price stability objective, the [Reserve Bank of New Zealand] Act requires that the Governor and the Treasurer negotiate and agree a Policy Targets Agreement (PTA)—effectively a contract providing the Governor with, to use the jargon of management consultants, his Key Performance Indicators. Once the PTA is signed, the Governor is free to implement monetary policy without further reference to or instruction from the Government. The Governor, who is the person in whom all the decision-making authority is vested, can be dismissed for inadequate performance in relation to the target set down in the PTA.
However, the Act also provides that the Government can unilaterally over-ride the primary objective (and the PTA entered into on the basis of that objective). Such an over-ride is to be effected by a formal, legal and public process. In the event of an over-ride being invoked, a new PTA must be renegotiated which specifies clearly the new target—that PTA is also a public document. And the Act provides that an over-ride can last for no more than one year before being explicitly—and publicly—renewed.
Elsewhere in the speech, the Assistant Governor mentions that
Consumer price inflation was chosen because of its familiarity to the public, but it is not the only possible measure and indeed may have some disadvantages.
It appears that not only the PTA is mentioned in the Reserve Bank of New Zealand Act, but the process of PTA negotiation is a formal, legal and a public process.
SBP, in its press release dated November 29, 2021, lamented that op-ed writers criticize SBP policies with the benefit of hindsight and then do not propose any tangible alternatives. I do not consider myself an op-ed writer, however, in the light of RBNZ Governor speech of 12 years ago, here is my proposal in real-time (without the benefit of hindsight):
Aap k bhai ka tangible alternative:
If inflation targeting is to be the primary objective of SBP, Pakistan should also have a Policy Target Agreement (PTA) and it should be formal, legal, and public providing explicit targets. Moreover, it should be mentioned in the SBP Act that a PTA will be negotiated.
In the absence of PTA, the primary objective is vague and leaves no room for accountability and performance measurement of SBP despite the finance ministry and SBP officials claiming to the contrary ad nauseam.
We may hear from the SBP and Finance ministry that let this Act through the parliament, and then we will arrange for a methodology to define the objectives. But, I am less than hopeful that such an arrangement, if not addressed as part of the SBP bill, will ever be negotiated, and if it is negotiated, it will be done in a formal, legal and above all a public process. Updating the SBP Act was a great opportunity to have a debate on the role and objectives of SBP, which has been wasted in the cloak and dagger of getting the SBP bill through by hook or crook.
Pakistan does not have to follow the New Zealand example. The current approach in New Zealand may be different from what it was in 2010. In the below tweet, the good professor gives examples of other countries where an inflation targeting regime is practiced. In most of those countries, the central bank is the one that sets the inflation target. Unfortunately, that model can’t work for us, as the language in the SBP Bill clearly states that the government will define the inflation target.
It’s a shame that in the 10 months (that we know of as the first draft was leaked in March 2021 over WhatsApp) that the draft was being discussed amongst the top technocrats of IMF, SBP, and Ministry of Finance, no one questioned the primary objective description. Apparently, they just copied and pasted it from an IMF manual.
We all know how I feel about SBP’s ability to control inflation (this time I won’t share that meme). In its brief on the SBP Amendment Bill, the Ministry of Finance states that
Focusing on price stability as the primary objective is sensible since inflation is one of the variables that the State Bank can influence directly through its tools,
Seriously? Can SBP really influence inflation? Mortgage depth in Pakistan is one of the lowest in the world. In addition, the share of private-sector borrowing in overall borrowing is less than 30%. The majority of private sector credit growth in the last 3 years is in subsidized credit (ERF, TERF, LTFF, MPMG).
Makes you wonder if inflation targeting is even an appropriate primary objective when the central bank has no capability to control inflation. What is MoF smoking?
Ok. Time for the meme.
2. Secondary Objective
The secondary objective is defined as
stability of the financial system without prejudice to the bank's primary objective.
I am curious about the bold part. I am not an expert in constitutional and legal language. Does "without prejudice" mean that SBP will continue with inflation targeting, even at the expense of sacrificing the stability of the financial system? What is the theory behind adding this bold phrase?
3. Deletion of fostering growth from the preamble
The ministry of finance brief provides the following justification for deleting "foster growth in the best national interest" from the preamble.
international experience has repeatedly shown that countries that prioritize growth at the expense of price and financial stability are not able to sustain growth and have repeated boom-bust cycles—rapid economic growth followed by a financial crisis
Subsequently in the MoF brief, there are multiple paragraphs, a few quoted below, explaining how SBP's price stability focus will create "sustainable growth". If “sustainable growth” is the objective of price stability, then it is common sense that SBP should have included "sustainable growth" in the objectives, howsoever SBP chooses to define sustainable growth, not that SBP's definition skills are any good.
• International experience has shown that price stability is a necessary condition for sustained growth and development. Countries where price stability is a primary objective tend to have lower inflation, as well as less volatility in both inflation and growth. In that sense, price stability is a necessary condition for sustained growth and development.
• By facilitating domestic economic and financial stability, the amendments will help support sustainable growth and avoid repeated booms and busts that have characterized Pakistan’s past and led to painful consequences in terms of higher inflation, higher poverty, and lower growth.
And in the below paragraph, MoF even talks about SBP prioritizing growth at the expense of inflation. Kia ye khula tazaad nahin?
•Conversely, if inflation is not because of excessive demand but because of supply shocks in the form of administrative issues that are driving food prices higher or because of increases in administered prices like electricity, growth would be prioritized and interest rates would not be raised unless these price pressures became more broad-based.
If there is so much emphasis on “sustainable growth” in the explanations, makes one question why was it deleted and not made a tertiary objective?
4. Final objective
The preamble states the final objective as supporting general economic policies of the Federal Government to
foster development and fuller utilization of country's productive resources.
This is a general statement that doesn’t say anything and is probably added to provide maneuverability to SBP for extraordinary circumstances. However, when the aforementioned is translated into the third objective in the Objectives section, it loses all coherence.
As per Section 4B, SBP can extend support to general economic policies of the Federal Government
with a view to contributing to fostering the development and fuller utilization of Pakistan's productive resources
I will appreciate it if anyone can explain to me what the bold part of the aforementioned objective means. In a matric examination, the examiner would cross out this sentence saying it adds needless verbosity and doesn't make sense.
I want to reemphasize that this objective follows from the preamble which is the first paragraph of the SBP Act, and the top technocratic minds of SBP, MoF and IMF came up with this.
5. Spelling
I guess IMF prefers the American spelling of utilization.
Is this the best that they could do?
There is no argument that laws and regulations need to be updated to deal with challenges that time and changing environment throws at us. Hence, I agree with the Ministry of Finance when it says that SBP Act had to be amended to bring it in line with best practices.
The role of the State Bank of Pakistan (SBP) as defined in the State Bank of Pakistan Act 1956 has undergone several changes over the years. Major revisions in the SBP Act were introduced in 1994, 1997, 2012 and 2015. These changes were carried out to bring the central bank legislation in line with best practices at that time and to enable it to deal with evolving issues effectively.
However, I don't think defining objectives in such vague terms, adding needless verbiage, and then holding press conferences after the fact to explain incoherent or vaguely written clauses in the bill is a best practice.
The bill has been in discussion for at least 10 months. It is expected that once approved by the parliament, it will not be amended for at least half a decade. If we are streamlining the objectives, this was an opportune moment to bring in succinct and clear objectives.
Moreover, as soon as the bill is approved, there will be felt a need for a succinct PTA. Unless the government moves another bill in parliament which provides for the PTA, there is no accountability of SBP, despite the number of press conferences and briefs issued by SBP and the Ministry of Finance claiming to the contrary.
Can you believe that the top technocratic minds at SBP, MoF and IMF came up with these objectives and didn’t feel a need to clarify them in the 10 months that we know they were discussing it amongst themselves? Quite a display of incompetence if you ask me. Should be embarrassing for those that came up with it if the first paragraph of the revised act comprises
Unclear primary objective
Allows for financial stability to be sacrificed at the altar of controlling inflation
Deletes growth as an objective yet the MoF briefs writes paragraphs on how the new objective will support growth and at one point says the growth will be prioritized over inflation.
Incoherent mumbo jumbo as the third objective.
Those who cannot even get into corridors of IMF are today criticizing it
— Dr. Abdul Hafeez Sheikh as Advisor to PM on Finance and Revenue. Former Senator and Finance Minister of Pakistan. PhD Econ from Boston University