A lot has recently been written about whether or not Pakistan’s Central Bank—The State Bank of Pakistan (SBP)—should be given more autonomy and be made less accountable to the State’s oversight. Amongst the experts one has read columns and opinions of former SBP governors, economic analysts and opinion makers, arguing one way or the other with some going as far as simply linking Pakistan’s future hopes to the extent of independence allowed to the central bank. The reality perhaps lies somewhere in the in-between. A central bank’s independence invariably lies within the limits set by the government and especially in the South Asian context, such an explanation is very well elaborated in the biographical account, ‘Strictly Personal’, of Dr Manmohan Singh, Reserve Bank of India (RBI) Governor (1982-85) and former Prime Minister of India (2004-14), written by his daughter Daman Singh. He explains at length why in developing countries with high debt, a central bank governor cannot be superior to the finance minister in authority or act completely independent of the financial needs of the economy. For example, only a couple of months back in February 2021, the RBI came out with a PAP (Prompt Action Plan) aimed at protecting the Indian banking sector from financial crisis, however, the government instead sought easing of lending norms for the micro, small and medium enterprises (MSME) sector. The MSME sector is the biggest employment-generating sector and contributes about 40 percent to exports and about 45 percent to the GDP. The PAP could have made lending to MSME very difficult and on direction of the Indian finance ministry, the RBI have had to retract since. A very seasoned and globally respected figure Dr. Y.V. Reddy who can be termed as one of the architects of modern India and perhaps largely responsible for the economically transformed India we see today, writes in his book, ‘Advice and Dissent’ (I also wrote a book review for him on this work) that there is no such thing as blanket independence. In essence, RBI should be independent within the limits set by the government. The tussle between the RBI and the government is as old as the RBI itself. The first RBI governor Osborne Smith (1935-37) had his differences with the then British Indian government. The friction between the RBI and the government was there when Jawaharlal Nehru was the prime minister. Benegal Rama Rau remains the longest-serving RBI governor 1949-57—since Independence. He had a bitter confrontation with Nehru’s finance minister TT Krishnamachari and PM Nehru threw his weight behind Krishnamachari, asking Benegal to either fall in line or resign—He fell in line!

Moving forward, so when we know that South Asia has a rather peculiar history of defining central bank’s independence, which may not entirely cater to its textbook definition, why all of a sudden this new urgency in Pakistan on changing the operating dynamics of the SBP; after all, the performance of central bank’s management on inflation and full employment (primary objectives) has of late, not been stellar? The answer seems quite obvious in that the requirement is primarily externally driven rather than internally desired. So, in order to evaluate that how seriously should such a significant demand (carrying long-term implications) be taken, in essence being made by the west-controlled donor institutions, it will be interesting to determine that is it just Pakistan specific or also being followed—in letter and spirit—in the developed western economies of the world; meaning are they practicing what they are preaching?

For example, when it comes to the United States (US), arguably the best modern-day model of market economy, it is generally assumed that (1) the Federal Reserve should be independent; and, (2) the Federal Reserve has always been independent. Well, a closer look and the second of these assumptions does not entirely come out to be as true. Here are a few examples of US Presidents pressuring the Fed: a) William Martin (1951 to 1970). President Eisenhower directed his Treasury secretary to put the “utmost pressure” on Martin to “get a greater money supply throughout the country.” When Martin refused, Eisenhower told him to reconsider or resign. Martin reconsidered. b) Arthur Burns (1970 to 1978). President Nixon repeatedly worked with Burns to ease monetary policy, with the view that it would help win elections. One of Nixon’s famous tapes captured the pair openly mocking the idea of Federal Reserve independence. c) William Miller (1978 to 1979). Finding Miller uncooperative, President Carter replaced him as Fed Chair, making Miller Treasury Secretary instead. And d) the latest, in tackling perhaps the biggest financial crisis ever in 2008, the New York Fed is on record in officially taking the following position in the US Supreme Court: “The US Treasury and the Federal Reserve System have long enjoyed a close relationship, each helping the other to carry out certain statutory responsibilities. This relationship proved beneficial during the 2008-09 financial crisis, when the Treasury altered its cash management practices to facilitate the Fed’s dramatic expansion of credit to banks, primary dealers, and foreign central banks.” In fact, the Fed’s congressional mandate requires it to focus on (among other things) full employment and inflation. Regardless of the mandate’s details, the more US debt the Fed holds, the more it enables deficit spending.

The other assumption, that the Fed should be independent, is more debatable. On the surface, it seems obvious that the Fed should operate independent of national politics. Otherwise, US monetary policy might be in shambles. Though this view as a slogan is very popular, yet, the Nobel winning economist Milton Friedman, for one, has often argued that the Fed should be brought under the direct control of the Treasury. Such a move, he argued, might result in more small policy mistakes, but it would prevent major disasters. So, whatever one’s view on the topic, the reality is that to assume that the Fed alone guides the monetary policy is being grossly mistaken. As it stands, the Fed Chair is a political piñata for both Congress and the President and by admitting to making the Treasury directly responsible in influencing monetary policy would remove one half of this sham. To be fair, to think that the Fed can do whatever it wants and is truly independent in law and deed, is tantamount to being woefully misinformed. However, on the other hand, to think the Fed is simply a political lackey of the president or the Congress is also being misinformed, because it is not. The reality is that the defining traits of the Fed’s “independence” are actually its ambiguity and flexibility. It is an elastic concept, meaning different things at different times for different reasons. The Fed’s basic tools are its ability to set short-term interest rates (the so-called fed funds rate on overnight loans) and to influence long-term interest rates (mortgages, government bonds) while partnering the government in working towards growth and full employment. Trust this as the limit that we here in Pakistan should also keep in mind and bat for when looking to set the central bank’s domain.

One must understand that from an economic governance perspective the monetary policy powers need to be delegated to the central bank for mainly two reasons. First, monetary policy—altering interest rates and credit conditions—is highly technical. Most politicians don’t have the time or the temperament to immerse themselves in the murky details. Second, and more important, these decisions are often highly unpopular. Sometimes, raising short-term rates is the right thing to do for the long run—containing inflation or financial speculation—even if the immediate effects are unpleasant. Political leaders generally shy away from decisions that can possibly entail public backlash. Even today, the latest debate in the US is about Fed’s autonomy, but merely that did the pendulum on its independence swung too far away under the Trump administration and should Biden do anything to address it or leave it as it is? Remains to be seen.

To conclude, the fundamental question that arises for us is that should the government of Pakistan amend the act pertaining to the proposed changes giving enhanced independence and reduced accountability to the SBP, and if yes, then to what extent should it go in loosening its grip on the country’s central bank? The latter first, on accountability, one feels that it is a no brainer. The sooner we take the state’s incompetent and counter-productive accountability institutions off the Bank’s back, the better. It will render its management the confidence to take its decisions based on pure merit. As on the former, the extent of autonomy and independence that should be given, perhaps the answer again lies in finding a middle ground. One cannot simply ignore the reality that elected governments are answerable to the public, as they are elected on the very promise of improving the economy and giving relief to the people. In being able to do so the central bank naturally has an important role to play and it would only be fair that it consults the government or even seek its permission, where necessary, before taking any major monetary policy decisions that can potentially either adversely affect people’s lives or disrupt the supply-side of governmental policies aimed at finding the correct economic equilibrium. For its part the government needs to ensure that it makes appointments in the central bank based only on merit (both competence and reputation) while genuinely respecting the independence of the State bank of Pakistan in most counts. This includes not just the top tier executive management at the central bank, but also a professional and diversified board needs to be put in place, which has the skills to oversee all facets: theoretical and prudent financial management. Once a robust institutional mechanism is put in place, the results will automatically follow.