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Monetary policy in Pakistan

By Dr. M. Hanif Akhtar,
 Department of Commerce,
 B. Z. University, Multan
                                                            Aug 28 - Sep 03, 2000

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 deficit financing.

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).

Table-1 Monetary assets in Pakistan

(annual average)
1

1950s

1960s

1970s

1980s

l990s

Stock of money                    (Rs billion)

5.16

13.29

41.10*

180.9

785.0

Growth rate (%)

7.8**

16.3

21.0

13.2

15.95

Notes:  The average is for the period 1971 to 1979. The average is for the years 1952 to 1959.
Source: GoP, Economic Survev. Various Issues.

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 these reforms.

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.