When the SBP autonomy bill was first introduced in Parliament in March 2021, it faced significant opposition. Critics were concerned about the lack of transparency in its swift passage, and many economists feared that granting the central bank greater independence would undermine Pakistan’s fiscal sovereignty. The primary concern was that the bill would limit the government’s ability to finance deficits through money printing, which some saw as a crucial tool for managing the country’s economic challenges.
However, the debate wasn’t just about nationalistic fears; it was rooted in practical concerns over the SBP’s revised mandate. By focusing solely on price stability, critics argued that the bill ignored other important aspects of monetary policy. In Pakistan, inflation is often driven by external factors like rising energy prices and currency depreciation, making inflation targeting alone insufficient. Some policymakers also pointed out that higher interest rates could worsen inflation by increasing the government’s debt burden, which is ultimately passed on to consumers.
Since the bill’s passage, Pakistan has faced record-high inflation, which has eroded purchasing power, particularly for low-income families. Despite this, the SBP has largely succeeded in demonstrating the effectiveness of positive real interest rates in curbing inflation. However, the broader challenge of comprehensive monetary reform remains unresolved.
A less discussed but important part of the autonomy bill allows the central bank to finance fiscal deficits indirectly through commercial banks. When these banks can’t meet the government’s borrowing needs, the SBP steps in, injecting liquidity into the market through open market operations (OMOs). Since the bill was enacted, the SBP’s monetary assets have grown by nearly Rs10 trillion, highlighting the scale of these liquidity injections.
While the direct borrowing from the SBP has ended, this indirect method through commercial banks raises the question of whether the central bank’s autonomy has truly curbed fiscal irresponsibility. Though OMOs offer a market-based way to determine government borrowing costs, they don’t address the core issue: the government’s continued reliance on debt to finance deficits.
On the positive side, the SBP’s autonomy has helped reduce the growth of reserve money (M0), which had previously been growing at an unsustainable rate. Since the bill’s passage, M0 growth has slowed, aligning more closely with GDP growth and inflation targets. This is a significant achievement, as excess M0 growth had been a major driver of inflation in the past.
However, the indirect lending mechanism has led to a rise in broad money (M2), which could pose long-term risks. The Rs9 trillion increase in bank borrowing from the SBP has contributed to a Rs13 trillion rise in commercial banks’ investment portfolios, much of which has been financed by OMOs. This growth in M2 could eventually lead to inflationary pressures or even asset bubbles, especially if it fuels risky lending by commercial banks.
To safeguard its monetary policy gains, the SBP must closely monitor broad money growth and its potential effects on inflation and asset prices. Careful management of liquidity injections is crucial, as excessive OMOs could undermine the progress made in controlling M0 growth. The SBP should also improve communication about its liquidity strategies to maintain market confidence.
The relationship between reserve money, broad money, sovereign borrowing, and inflation is complex and not fully understood. While the SBP has made progress in controlling reserve money growth, the surge in broad money raises critical concerns about future inflation or financial instability. The central bank must remain vigilant, as the next inflationary crisis could arise not from reserve money, but from unchecked broad money growth. Enhanced monitoring, proactive policy interventions, and further research into these dynamics are essential to avoid potential risks and ensure the sustainability of the progress made so far.
