RECENTLY, the State Bank unveiled its strategic vision for the next five years. This vision encompasses six goals, including controlling inflation, financial stability, broader access to financial services for the general public, promoting Islamic banking and finance, advancing digital finance and making the State Bank technology-driven and people centric. The most notable aspect of this vision is the comprehensive exclusion of the goals of economic growth and employment provision from the list. Historically, central banks have consistently pursued three goals—namely, price stability, economic growth and employment. While the prioritization among these three goals has fluctuated over time, they have always been integral to the objectives of central banking since their inception. However, in the 1990s, a new trend in central banking emerged known as inflation targeting. In inflation targeting, controlling inflation takes precedence, relegating other goals to secondary status.
If controlling inflation is given primary importance, how much significance can be attributed to other goals? Several countries have different laws governing this matter. Several central banks have excluded references to economic growth and employment from their list of primary goals. In late 2021, Pakistan enacted legislation that modified the State Bank’s goals, emphasising inflation control as primary, while relegating economic growth and others to tertiary status instead of secondary. Furthermore, the strategic vision of the State Bank removed economic growth and employment even from the list of tertiary goals.
Determining priorities in goals entails not just changes in words or their order but can also be a fundamental shift in practical wisdom. For instance, 2019 and 2023 were the years when the rate of economic growth declined from 6 per cent to less than 1 per cent. If the central bank was prioritizing growth and employment, interest rates should be reduced to facilitate an increase in employment and economic growth. However, in both of these periods, the SBP prioritized controlling inflation, maintaining a series of interest rate hikes, resulting in severe damage to both the objectives.
Choosing among the alternative practical wisdom that prioritizes elements other than employment in a society facing economic challenges and lacking strong social security is an undesirable decision. Depriving millions of potential job opportunities is a great injustice with the economy and society. However, for this injustice, Pakistan’s Parliament, with the cooperation of all political parties enacted the so-called SBP Autonomy Bill.
But an even greater injustice is that the practical wisdom exercised in the name of inflation targeting is counterproductive. That is, a policy intended to reduce inflation is actually increasing it. In early 2018, the interest rate in Pakistan was 5.75%, while inflation was 4%. Fearing from an anticipated inflation, the State Bank initiated a series of interest rate hikes in late 2018, continuing until 2022. The Monetary Policy Statements from the State Bank during these five years testify that the primary purpose of increasing the interest rate was to reduce inflation. However, instead of decreasing inflation, it actually increased. In late 2019, when the interest rate was 13.25%, the inflation was over 15%. In 2020, due to the relief provided amid the COVID-19 pandemic, the interest rate was temporarily reduced to 7% and the inflation also decreased proportionately. In 2021, with the resumption of interest rate hikes, inflation started rising again.
Observing that increasing interest rates did not lead to a decrease in inflation, the justification for the continued increase in interest rates and keeping it at such a high level needs to be questioned. According to popular economic theory, there is a negative relationship between interest rates and inflation, meaning that an increase in interest rates should lead to a decrease in inflation. However, this theory does not hold true in reality and numerous economists, including Nobel laureates Christopher Sims and Joseph Stiglitz, have identified the failures of this economic theory.
Despite the global recognition of the shortcomings of this theory, international financial institutions continue to prioritize policies based on it, imposing them forcefully on countries trapped in their grip. Many developed countries have adopted a different approach, prioritizing economic development and employment despite having inflation targeting as the central bank’s sole objective. Currently, Pakistan’s interest rate is 22%, while neighbouring countries, including India and Bangladesh, have interest rates of less than 6%. Consequently, if the Indian government borrows from its central bank or a commercial bank, it would have to pay interest at the rate of 6%. In contrast, if the Pakistani government borrows from a commercial bank, it has to pay interest at a rate of 22%. This substantial difference in interest payments has contributed to interest payments exceeding 50% of the federal budget.
The largest expenditure in Pakistan’s budget is not for defence but for interest payments, which are over 300% more than the defence budget. This high expenditure is due to the State Bank’s insistence on inflation targeting. However, it is astonishing that the State Bank has never evaluated the effectiveness of this most expensive decision. There is no analytical report available from the State Bank that discusses the benefits and drawbacks of such a high-interest rate. The tens of thousands of billions of rupees spent on false assumption, without any solid reason and economic analysis.
I request my readers to use their capacity to engage in a comprehensive discussion on the benefits and drawbacks of the State Bank’s policy and urge the State Bank to present an analytical report on the effectiveness of its policy. If this is not the case, the policy should be discontinued, saving trillions for the nation and the interest rate should be brought down to 4% so that businesses could be financed at a reasonable rate, people can find job opportunities and economic growth becomes possible. We are located close to the economies growing at a staggering 8% and if we adopt a policy that suppresses development, we will remain far behind. If this policy continues, sooner Pakistan Would be cited as an example of an economy with hunger and poverty instead of Chad and Somalia.
—The writer is Director, Kashmir Institute of Economics, Azad Jammu and Kashmir University.
Email: [email protected]
views expressed are writer’s own.
