Monetary policy in Pakistan has been used in co-ordination
with the fiscal policy to achieve both the objectives of macro-economic
stability and higher economic growth. The government supervises monetary
situation of economy through the State Bank of Pakistan (SBP). This article
attempts to present an overview of the monetary policy in Pakistan overtime.
During the decade of fifties, monetary policy was used to
correct external balances in the economy. The government followed the tight
monetary policy during the early fifties to prevent inflationary tendencies in
the economy. But there was an increase in the money supply because of the
The phenomenon of monetary expansion continued during the
sixties (Although growth rate of money supply slowed down in the late fifties).
Increase in bank rates, cash reserve requirements, liquidity ratios, abolition
of credit quotas and the imposition of credit ceiling etc. were the main
measures because of rapid increases in private investment and growth of GDP
(6.8% in 1960s). The government tried to restrict money supply in the economy to
counteract inflation because of conflict with India in 1965 and crop failure in
1966. However, heavy defence expenditures and cut in aid flows forced the
government to resort to deficit financing for correcting the fiscal imbalance.
It would be pertinent to mention that inflation rates remained low (3.8%, annual
average) during this period. This was due to an improvement in the economy and
steps taken by the monetary authorities (e.g. increase in bank rates, cash
reserve requirements, liquidity ratios, abolition of credit quotas and
imposition of credit ceiling).
assets in Pakistan
Growth rate (%)
Internal and external shocks (mentioned above) and
devaluation of Pakistani currency resulted in slow growth of the output and
higher monetary expansion leading to a rise in the general price level during
the seventies. Increase in the public and private borrowings did also increase
money supply in the economy. The SBP adopted various measures to control the
money supply but achieved limited success in this regard.
The eighties started with financing of the budget deficit
mainly through external borrowings and bank sources. As a result of this
strategy, not only external indebtedness increased, it also led to inflation in
the economy (about 12.5% during the years 1981 and 1982). Hence, the government
resorted to non-bank borrowings as a major source of financing the public
deficit during the period 1983-90. The move was justified on account of debt
crisis in the eighties and to prevent inflation as well. As a result of this
policy-shift, inflation remained under control (6.0% on average) during the
period 1983-90. Lack of domestic resource mobilization and the shortage of
foreign loans forced the government to make a hesitant move for additional funds
from the World Bank as a part of the structural adjustment loan (SAL) linked
with stringent conditions. Resentment on part of the government resulted in
disruption of these funds, time and again.
During the 1990s, the government introduced various financial
reforms through the market-based instruments of monetary management. Increase in
reserve requirements, privatisation of commercial banks, license to establish
private commercial banks, greater financial autonomy to the SBP, development of
secondary markets in government securities, increase in commercial lending
rates, credit control and capital market reforms etc. are the main features of
Bank borrowings remained an important source of financing the
budget deficit as 32% of the total deficit was financed through such sources
forming 2.9% of GDP during the period 1990-96. Such a mode of financing the
deficit not only affected the pace of monetary expansion (table-1) but also
accelerated the rate of inflation (10.6%), higher than annual average (7.3%) of
the eighties. The bank borrowings soared up as a result of financial reforms and
the government needs for retirement of the non-bank debt. With the introduction
of financial reforms, certain non-bank borrowing instruments were suspended,
resulting in lesser availability of funds. This trend has reversed during the
recent years as domestic non-bank borrowings have largely been used to
accommodate the fiscal deficit. The government has also followed a policy of
retiring the debt borrowed through the banking system.
As far as the stock of money is concerned, it has grown up
enormously during the nineties as compared to that in 1980s. It has grown up at
varying rates and stands up about four times higher than what it was during the
preceding decade. The average growth rate of money supply during the 1990s has
been at par with that of in the sixties but relatively higher than that in the
fifties and eighties. The government has tried its level best to contain the
growth of money supply through various measures during the recent years.
Meddling in monetary policy is usually symptomatic of government failure in
fiscal arena. Hence, there stands a need for concerted efforts to rectify the
fiscal sinfulness in Pakistan. How to reduce the fiscal deficit is another area
of debate. However, fundamental solution lies in expanding the tax net and
retiring the foreign debt. Mere tinkering with money supply will only preserve
misalignments and convulsion in other economic areas.
What needs to be done?
For an effective monetary management of the economy, public
sector deficit has to be contained. The policy of financing the deficit through
bank sources has led to greater monetary expansion and higher rates of inflation
whenever the monetary authorities adhered to such a mode of financing the
deficit. This trend of financing the deficit needs to be changed to constrain
and reduce inflation in the economy while rate of growth of output needs to be
improved as well. Credit constraints to private sector, especially for
non-productive purposes, would also help to control money supply in the economy.