The Role of Monetary Policy in Pakistan’s Economic Stability and Growth

Monetary policy involves the central bank's use of instruments to influence interest rates or money supply in the economy with the objective of keeping overall prices and financial markets stable. The Preamble to the SBP Act 1956 envisages monetary policy to secure monetary stability and attain fuller utilization of the economy’s productive resources. In SBP’s view, the best way to achieve these objectives, on a sustainable basis, is to keep inflation low and stable. Low and stable inflation, in turn, provides favorable conditions for sustainable growth and employment generation over time. It reduces uncertainties about future prices of goods and services and helps households and businesses to make economically important decisions relating to consumption, saving and investment with more confidence. This facilitates higher growth and creates employment opportunities over the medium term, leading to overall economic well-being in the country.

The monetary policy framework of Pakistan has gradually evolved, from the implementation of credit allocation plans to monetary management, to the current approach which is reminiscent of implicit flexible inflation targeting. Without delving into the intricacies and technical details of these different approaches, suffice it to say here that even as the framework has undergone changes, the core objective of monetary policy has remained consistent, i.e. maintaining price and monetary stability, keeping in view the inflation and growth targets set by the government.

More specifically, in the past few years alone, the conduct of monetary policy has witnessed some notable enhancements. These include improvements in: (1) the quality of the monetary policy decision; (2) the technology and inputs, which feed into decision-making; and (3) communication of the decisions.  All of these dimensions of monetary policy have evolved over time, which is what we elude to next.

Firstly, regarding the quality of the decision, a key development is the formation of an independent monetary policy committee. In order to bring monetary policy decision-making closer to international best practices, the SBP Act 1956 was amended by Parliament in November 2015 to set up a statutory Monetary Policy Committee (MPC) with three external economic experts, three SBP senior executives and three SBP board members. The MPC was given the responsibility to formulate, support and recommend monetary policy. It may also, as appropriate, make decisions relating to intermediate monetary objectives, key interest rates and the supply of reserves in Pakistan, and propose regulations for their implementation. This independent MPC meets regularly during the year to review and deliberate on SBP’s policy stance, keeping in view the overall macroeconomic conditions and their projections.

Secondly, with respect to inputs that feed into decision-making, SBP has extensively focused in recent times on adopting the conduct of forward-looking monetary policy based on its inflation forecasts. In terms of major economic indicators, the central bank keeps a close eye on and apprises the MPC of developments in the external sector, monetary aggregates, credit to private sector, and global developments, along with an extended assessment of present and future determinants of inflation and real growth levels in the economy. Furthermore, various primary data collected at SBP has regularly been provided to the MPC, together with data sets from surveys on expectations. Advanced data visualization has also been facilitating informed monetary policy decision-making.

Thirdly, regarding communication of monetary policy, SBP communicates its monetary policy stance primarily through its website and press releases. The monetary policy decisions taken every alternate month are disseminated via Monetary Policy Statements that contain brief analysis of economic conditions and the rationale behind the monetary policy decision. Moreover, since 2016, the Monetary Policy Statements are being supplemented by detailed minutes of the MPC meetings released on the central bank’s website. These minutes document the proceedings of MPC meetings, including the analysis presented by SBP staff to the committee, and also the voting pattern of MPC members. The publication of these minutes helps to align market expectations, while enhancing the transparency and credibility of monetary policy decision-making. In addition, following the monetary policy announcement, representatives from SBP higher management also make presentations at various forums and gives interviews to the print and electronic media to explain the monetary policy stance.

So that effectively sums up the recent developments relating to the monetary policy framework in Pakistan. At this point, one may wonder what role the monetary policy has played in fostering macroeconomic stability and growth so far . An accommodative monetary policy stance - including a historic low 5.75 percent policy rate introduced in May 2016 and maintained until the January 2018 MPC decision - along with improvements in both security and energy situation, has led to healthy credit creation in the economy in the last couple of years. Encouragingly, a major chunk of the bank credit has gone for fixed investment purposes, which implies that the productive capacity of the economy is set to rise. At the same time, average headline inflation for FY18 is expected to remain below its target for the third year in a row, and consumer confidence has also improved on the whole. Essentially, real GDP growth is consistently improving while the potential of the economy is rising. Only recently has SBP raised the policy rate in the backdrop of external sector imbalances and some concern that the economy may be overheating; in fact, the initiation of this tightening in January 2018 was itself a proactive measure on the part of SBP, and reflects how responsive the monetary policy approach is at present.

In conclusion, SBP's strategic plan – the Vision 2020 - envisages formal implementation of a Flexible Inflation Targeting (FIT) regime as a key policy objective going forward. The adoption of this policy framework would further enhance SBP's core objective of ensuring price stability while pursuing higher and sustainable economic growth. Thus, monetary policy will continue to play a dynamic role in relation to the country’s economic stability and growth prospects, and SBP remains committed to continually refining and upgrading its approach and decision-making frameworks in order to achieve the stated objectives.