Is an independent central bank in Pakistan’s favour? If so, what are the reasons?
It is now generally agreed that independent and accountable central banks lay a good foundation for low inflation and sustained growth. Globally, jurisdictions with more autonomous central banks have succeeded in achieving better outcomes in terms of growth and employment. Likewise, operational autonomy allows central banks effective utilization of the tools at their disposal, enabling them to achieve the objective of price stability, in addition to ensuring financial stability and supporting economic growth. Independence of a central bank is critically important for its credibility – confidence of the market that the central bank is authorized and suitably equipped to take necessary measures, without external pressures, to achieve its objectives. This credibility, in turn, helps a central bank to achieve its primary objectives of price stability, financial stability and growth, with relative ease. The proposed amendments in the SBP Act will ensure that price stability is achieved in an independent and transparent manner, leading to macroeconomic stability and sustainable growth in Pakistan. Particularly, in times of uncertainty, if markets have trust in the central bank’s ability to deliver on price stability, the central bank achieves this objective even with a lesser level of policy interventions.
Dr. Reza Baqir was appointed as the Governor of State Bank of Pakistan in May, 2019. Prior to the becoming the SBP Governor, Dr. Baqir had eighteen years of experience with the IMF and served it in different key positions. He served as the Head of the IMF’s Office in Egypt and held numerous other assignments, including Division Chief of the IMF’s Debt Policy Division, Head of the IMF delegation to the Paris Club and Deputy Division Chief of the IMF’s Emerging Markets Division. He has recently been appointed as the Chairman of the General Assembly of Islamic Financial Services Board (IFSB) in Pakistan. Dr. Baqir holds a PhD in Economics from the University of California at Berkeley and an A.B. (Magna cum Laude) in Economics from Harvard University.
How would you comment on the relations of the IMF with Pakistan and its impact on the economy?
IMF and Pakistan authorities continue to exchange views on the economy and discuss ways to address the challenges faced by the Pakistan economy. Differences occasionally arise between the Pakistan authorities and the IMF on the tools and methods to be used to achieve our shared goals. This is normal. Ultimately, both parties are able to bridge gaps and move on. Keeping in view the economic challenges faced during the last few years, the position we are in today speaks of the success of the program. Admittedly, difficult structural adjustments and reform measures have helped to build buffers and create fiscal space to tackle challenges of the COVID-19 pandemic. Naturally, the stabilization measures result in slower economic growth and adjustments in prices that adversely affect the lower income segments. This impact has been compounded by slower economic activity induced by the COVID-19 pandemic as well as higher inflation.
What is the role of Islamic banking in the economic growth of the country?
The role of the Islamic economic system is to bring greater justice to achieve socio-economic development and fulfillment of basic financial needs of all segments of the society. Islamic banking provides an additional benefit of achieving the objective of development with distributive justice by increasing the supply of risk capital in the economy, facilitating capital formation and contributing in real sector business activities.
The characteristics of Islamic finance products are aligned to bridge the financing gap to achieve sustainable development. Shariah compliant modes of financing have a natural nexus with productive activities in crucial real sectors, particularly agriculture, SMEs and low-cost housing.
Given its potential towards ensuring broad-based economic growth and development, increasing financial inclusion by promoting Islamic banking in the country is an explicit component of SBP’s Strategic Plan. Moreover, Islamic banking is also an integral part of our National Financial Inclusion Strategy to address both voluntary and involuntary financial exclusion. Being a country with more than 95% Muslim population, I believe that there is a huge potential for Islamic banking in Pakistan to achieve broad-based economic growth and development. SBP has recently issued its third five-year Strategic Plan (2021-25) for the Islamic Banking industry with headline target of 30 percent share in the assets and deposits of the overall banking industry.
There is immense un-tapped potential to exploit. Even now, direct contribution of Islamic banking in the economic growth of Pakistan can be gauged with some relevant numbers. Islamic banking has now acquired a market share of 17 percent and 18.7 percent in assets and deposits of the banking industry, respectively. Currently, 5 full- fledged Islamic banks and 17 conventional banks having Islamic banking branches are providing Islamic banking products and services across 124 districts of the country with a branch network of 3,504 branches along with 1,595 windows. The implementation of the 3rd 5-year Strategic Plan will bridge the gap between now and five years down the road.
Pakistan’s foreign debt and liabilities have been rising rapidly over the last several years. Is there a way out?
In order to understand the issue, let us focus on the last few years. Our rapidly growing economy started showing signs of heating up during FY18, especially visible in widening current account and fiscal deficits, and rising core inflation. Unwarranted stabilization of the exchange rate, that led to its overvaluation, and expansionary fiscal policy fuelled demand pressures in the economy. As a result, current account and fiscal account deficits increased to unsustainable levels of 6.3 percent and 6.6 percent of GDP, respectively in FY18. Specifically, widening current account deficit, coupled with its insufficient financing weakened foreign exchange buffers of the economy, severely affecting its ability to meet external obligations. This required urgent policy decisions to correct the imbalances impeding economic growth. The exchange rate adjustment and subsequently the adoption of a market-determined exchange rate regime by May 2019 have already started to provide benefits to the economy and would potentially yield many other long-term benefits including: one, sustainable improvement in the current account; two, increase in workers’ remittances inflows through formal channels as kerb premium coming down substantially; three, build-up of foreign exchange reserves; and four, resilient economy with the incentive structure to focus on increasing exports and substituting imports.
The rising foreign exchange reserves will reduce the probability of Pakistan resorting to the IMF and the other lenders for raising debt. Concurrently, there is the need for policies that can increase non-debt creating foreign inflows in to the country. Improving property rights, focusing on ease of doing business and investing in human capital are going to result in such inflows in the coming years. Over time, this would reduce the country’s debt as well as its reliance on external creditors.
What are the major achievements of SBP during the last four decades?
The creation of the statutory Monetary Policy Committee (MPC) that includes independent economists in 2016 has been instrumental in proactive and forward-looking conduct of the monetary policy every two months as well as whenever needed. Since its inception, many international best practices have been adopted that add to the SBP’s credibility. A framework for the conduct of monetary policy based on detailed assessment of the macroeconomy and projections of key economic variables has been developed and in use by the SBP to appraise MPC members. In order to enhance the transparency, minutes with voting pattern of the MPC meetings are released. Recently, forward-guidance has also been introduced. All these aspects improve anchoring of inflation expectations in the economy, which has strong implications for real growth.
Recently, in order to correct the external sector imbalances and their reoccurrences, SBP spearheaded the implementation of a flexible market-based exchange rate policy. Since its adoption in May 2019, a significant improvement in the external sector has occurred. Current account has remained in surplus during the first eleven months of FY21, workers’ remittances inflows have increased sharply through formal channels, RDA has supported investments by overseas Pakistanis and foreign exchange buffers have improved significantly.
On the banking side, I would refer to the creation and development of the Islamic Banking industry in the country. A well-developed Islamic banking sector has coexisted formally since 2002. Pakistan is one of the few countries that has made necessary modifications in the legal framework to perform banking business strictly in conformity with the injunctions of Islam. Accordingly, State Bank of Pakistan is fully committed to promotion of Islamic banking as planned in its 3rd five-year strategic plan 2021-25 for Islamic Banking Industry by setting a target of 30% market share of Islamic banking in overall banking industry. Currently, there are 5 full-fledged Islamic banks and 17 conventional banks operating with standalone Islamic banking branches in Pakistan.
What goals has SBP set for itself in the long-term?
The future direction for the SBP is to be an independent and credible central bank that achieves monetary and financial stability for the long-term benefit of the people of Pakistan by maintaining inflation close to its annual and medium-term targets, while also focusing on economic growth and employment.
In this regard, amendments have been proposed to the SBP Act of 1956 that allow it to move towards formal adoption of Flexible Inflation Targeting (FIT), along with further accountability of SBP, and formal discontinuation of direct deficit monetization. Most importantly, the proposed amendments include revision in key objectives of the SBP to bring them in line with world best practices by clearing the current ambiguity regarding their interpretation. Along with the primary focus on price stability there is provision of financial stability as the secondary objective while economic growth comes in as the tertiary objective.
Along with these goals, there are some emerging needs as well. Looking at the growing interest of consumers, SBP is committed to further enhance the scope of Islamic banking as well as its regulatory framework. Work on digitization of the financial system is also of primary importance, especially relating to the current debate regarding allowing digital currencies to operate freely or bringing out the country’s own digital currency managed by the central bank. Similarly, increasing financial inclusion and efforts for provision of credit to the underserved segments of society are SBP’s developmental goals. Newer initiatives such as green banking, climate change and enhanced women participation to narrow the gender gap in the financial sector are on SBP’s agenda too.
As a regulator, how do you view the growth of the banking sector?
It is encouraging to note that the banking sector has performed reasonably well despite the onset of Covid-19 pandemic last year. As per the latest Financial Soundness Indicators of the banking sector, as of quarter ending March 2021, there has been double digit growth of around 16.3% over the same period last year, in the assets of the banking sector. The banking sector has also earned healthy profits with return on equity (ROE) at 21% during the same period. Moreover, deposits have recorded impressive growth of 16.4%. Due to the Covid-19 pandemic, however, the increase in advances has remained sluggish at 2.2%. But notably, the Net NPLs of the banking industry are still contained at 1.3% of the advances and the industry has remained well capitalized with Capital Adequacy Ratio (CAR) above 18%. Based on these performance indicators and the current containment of the pandemic, I am quite hopeful that the banking sector, including the advances, would observe significant growth in the future.
How soon do you think the country would be out of the FATF grey list?
In June 2021 Plenary, FATF considered Pakistan’s progress on 26 out of the 27 action items of the 2018 action plan. Pakistan authorities have remained committed to improving the AML/CFT regime since 2018 and, considering the unprecedented progress made on 26 items out of the 27 items of the 2018 action plan, we are hopeful that Pakistan would be able to demonstrate significant progress on this last remaining item of FATF Action Plan by the next plenary in October 2021. 
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