Group members:

Asif Ali

Aakash Ahuja

Mohammad Zeeshan Babar

Umer Latif

Mohammad Farhan Ali Khan

Monetary Policy

Introduction

ASIF ALI

MONETARY POLICYMonetary policy is about management of

volume of quantity of money.Monetary policy comprises measures taken

by the government and the central bank to regulate monetary flows.

It also performs allocative functions in the economy.

Monetary policy

intermediate targets

Economic growth

Price stability

Interest rate

targeting

Money stock

targeting

Nominal income

targeting

Credit plannin

g

Spread b/w S.T and L.T loan

Commodity price

MONETARY OPERATING PROCEDURE

O M O C R R S L RCredit ceiling

Credit rotating

Credit quota

Repo windo

w facility

MONETARY POLICY OBJECTIVESA) Economic growth(short term): continues economic expansion through the

optimum utilization of resources.B) Price stability(long term): Controlling inflation which is now becoming

almost an integral part of an economic landscape in underdeveloped countries.

INTERMEDIATE TARGETS

Targets set by the Federal Reserve as part of its monetary policy goals. Intermediate targets can be any economic variable that is not directly controlled by the central bank

It includesInterest rate targeting Money stock targetingNominal stock targetingCredit planning commodity pricesSpread b/w short and long terms loan

MONETARY OPERATION PROCEDURE1) Open market operation: This consist of the purchase and the sale of

securities by the central bank in the open market.

This instrument is used not so much to control credit as to iron out seasonal fluctuations in the money market.

There is no large and specialized market for securities in Pakistan an therefore its effectiveness here is marginal.

2) Credit ceiling:A credit ceiling can exercise some influence over

the total volume of credit though not on its direction or use.

This system while keeping credit volume in check may temp the banks to provide more finances to low priority enterprises.

3) Liquidity ratio:This is a ratio between a banks liquid recourses

and its total liabilities.While a low liquidity ratio may lower public

confidence in the banking system.A high liquidity ratio adversely affects the credit

flow in the economy and the overall profitability of the bank

4) Credit quota:The central bank can also limit its own

lending to banks by fixing a credit quota for each bank.

5) Cash reserve requirement:All scheduled banks are required to deposit a

certain percentage of their total liquid assets with the central bank.

A rise in the cash reserve requirement restricts the bank’s lending operations.

A fall can encourage them to advance more credit.

In Pakistan, in addition to these instruments, the state bank of Pakistan also

offers informal advice, guidance, and persuasion to banks in various matters.

Decade Objectives Tools used Impact

1950s Rapid growth & expansion of economy

Negligible / no tools used

GDP growth = 3.1%Inflation = 2.1%Monetary Expansion = 6.27%

Monetary Policy(1959 to 1977)

Aakash Ahuja

The year 1959-60 marked the beginning of a phase of liberalization and deregulation of the economy and substantial flow of resources from abroad.

The Government’s liberal economic policies met with an enthusiastic response from the private sector.

Both the expansion in investment and production entailing liberalization enhanced demand for credit in the private sector.

With high growth rates of investment and production as well as large movements in the external accounts, policy changes were made by the State Bank to keep pace with these developments and adequately meet the genuine credit needs of the economy.

Change in the Bank Rate from 3 to 4 % on January 15, 1959 (to supplement fiscal policy to check inflationary pressure).

The Bank Rate was changed from 4 to 5% on 6th June, 1965 Had no effect on the level of bank advances and failed to exercise any

influence to reduce consumption. Up to 1972 the main thrust of the State Bank policy was based on the

belief that any increase in the interest rate would adversely affect the investment activity.

Even in 1962-63 when credit to the private sector had expanded considerably SBP introduced the quota system and did not favor an increase in the Bank Rate because of the Bank’s perceived adverse implications of such a measure for the country’s economy.

By 1972, it was realized by the SBP that the policy of not making significant changes in the Bank Rate, because of its likely adverse impact on demand for credit, needed to be revisited.

Realizing that availability of bank credit mattered more than its cost, the Bank authorities became more flexible on the interest rate policy.

On May 11, 1972, the Bank Rate was also raised from 5 to 6% accompanying the devaluation decision.

Rate was gradually raised to 10%

Interest Rate Policy

As part of containing credit expansion to a prudent level the State Bank introduced the Quota System on 1st August 1963.

Borrowing in excess of the quota (against govt. securities) was subjected to enhanced rate of interest.

Changes in the Reserve Requirements and the introduction of the Quota System were found to be ineffective in correcting the monetary situation.

Both the government and the private sector continued to borrow heavily during 1963-64, and Monetary Assets expanded by 16.9% despite a contractionary influence of the external sector. Earlier, Monetary Assets had increased by 17.2% during 1962-63.

Quota System & CRR

In January 1965 all types of borrowing were covered by the quota system including bank borrowing by the central and provincial governments.

Banks’ borrowing entitlement against government securities was reduced from 50% to 25%.

Borrowing in excess of the quota was subjected to graduated penal rates.

Not withstanding these measures credit to the private sector continued to expand and the government’s bank borrowing also increased following the 1965 war.

As a result of a record expansion in Monetary Assets (M2) of Rs. 2036 million during 1965-66, imbalance between demand and supply put pressure on prices which increased by 5.7% during 1965-66 and 10.3% during the following year.

However, credit demand from the private sector continued to expand. As a result, in the middle of 1967 the State Bank increased the Reserve Requirement to 6.25% (later to 7.5%) and introduced a whole range of selective credit controls.

Quota System& CRR

During 1959-72 the State Bank made extensive use of Selective Credit Controls to achieve the objective of monetary policy.

Selective credit controls aim at channeling bank credit to socially desirable and economically useful purposes.

Selective Credit Controls pre-dominantly consist of changes in minimum margin requirements to be retained by banks on advances against various commodities, to various borrowers, ban on advances against selected commodities, margins against letters of credit etc.

These were used mainly to (a) direct the flow of credit to selected sectors and sub-sectors (b) to prevent the build-up of inventories particularly of commodities of daily use and (c) serve as an adjunct to import policy.

Selective Credit Control

The Statutory Liquidity Ratio (SLR) was raised from 25% on 1st September, 1967 to 30% on 6th June, 1973. It was further raised to 35% on 16th August, 1973, to absorb a part of excess liquidity entailing large scale monetary expansion in the preceding year.

But raising the SLR could not control the overall volume of credit as it could only influence its distribution between the public and private sectors, or else would result in crowding out of the private sector if targeted overall credit expansion was kept unchanged.

SLR

At the macro level, credit budgeting was an effective instrument of monetary policy in terms of providing adequate liquidity for the development process without generating unmanageable price increases.

Also, credit budgeting was very helpful in directing bank credit to previously neglected priority sectors of the economy.

However, credit ceilings tended to adversely affect commercial banks’ incentive to mobilize deposits.

Not only did credit for budgetary support enjoy prior claim over all other credit allocations, very often the Government borrowed excessively from the banking system. (Actual borrowing exceeded target significantly).

Credit Planning & Credit Ceiling (After 1972)

The State Bank authorities constantly monitored the movement in prices for a possible policy change to contain inflationary pressures.

Whenever the Bank felt necessary, measures were taken to contain demand through credit management.

When the third Five-Year Plan (1965-66 – 1969-70) placed greater emphasis on heavy industries and infrastructure, the State Bank unified Cash Reserve Requirements (25th July, 1963) and introduced the Quota System in respect of scheduled banks’ borrowing from the State Bank against government securities.

The excessive monetary expansion was mainly accounted for by large scale deficit financing.

The Third Five-Year plan had envisaged that deficit financing in the entire Plan period would remain within Rs. 1500 million. Actually, deficit financing during the Third Plan period amounted to Rs. 4350 million, (Rs. 4.35 billion), though both the growth rate and availability of aid were less than the original estimates.

Monetary Policy, Growth & Inflation

Monetary Expansion and Prices

00.050.1

0.150.2

0.250.3

0.350.4

0.45

M2/

Y

-6-4-2024681012

Rat

e of

Infla

tion

Ratio InflationMoney Supply, Inflation and Economic Growth: Issues in Monetary

Management in PakistanM. Ashraf Janjua*

Monetary Expension, Economic Growth and Inflation 1972-1988

0

5

10

15

20

25

30

35

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17

(%)

0

5

10

15

20

25

(%)

CPI Monetary Grow th GDP Grow th (fc) Inf lationary GapMoney Supply, Inflation and Economic Growth: Issues in Monetary

Management in PakistanM. Ashraf Janjua*

Monetary Policy(1978-90’s)

MOHAMMAD ZEESHAN BABAR

1980’s To take corrective measures to improve the system. To stabilize the price level To ensure economic growth Credit Ceiling GDP growth = 6.58% Inflation = 7.22% Monetary Expansion = 15.02%

Economic Growth and Inflation During 1978-88 However, during the Bhutto regime sizeable public

investment took place in mega Public Sector Projects. Thus, if during 1974-75 the budget deficit was 10.6% of the GDP, the public sector program was over 10.2% of the GDP. Economic benefits of these heavy investments were largely reaped by the Zia-ul-Haq regime.

Economic growth during the Zia-ul-Haq period was quite impressive, rehabilitation of private sector and the law and order situation. Also, there was no political intervention and economic management was essentially in the hands of experienced bureaucrats.

average growth rate for the Zia-ul-Haq period were 6.6% and average price increase of 7.3%.

End June Consumer Price Index

(CPI)

Monetary Growth

GDP Growth

Inflationary Gap

(fc)

(a) (b) (c) (b-c)

1978 7.8 23 7.8 15.21979 6.6 23.5 5.6 17.91980 10.7 17.6 6.9 10.71981 12.4 13.2 6.2 71982 11.1 11.4 7.6 3.81983 4.7 25.3 6.8 18.51984 7.3 11.8 4 7.81985 5.7 12.6 8.7 3.91986 4.4 14.8 6.4 8.41987 3.6 13.7 5.8 7.91988 6.3 12.3 6.4 5.9Money Supply, Inflation and Economic Growth: Issues in Monetary

Management in PakistanM. Ashraf Janjua*

1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 19880

5

10

15

20

25

30

CPImonetary growthGDP GrowthInflationary Gap

The Government, the State Bank and Monetary Policy

The actual budget deficit was larger than the original estimates, mainly because of the Government’s over-estimation of revenues and under-estimation of expenditure

An attraction for government borrowing from the banking system was the sizable subsidy involved.

There was no limit on government borrowing from the banking system

Such changes have constituted an element of uncertainty and very often a leakage in the management of monetary policy

Bank borrowing: govt Non-govt

Target

Actual Target Actual

Zia ul haqregime

64.3 105.6 142.21 162Money Supply, Inflation and Economic Growth: Issues in Monetary Management in Pakistan

M. Ashraf Janjua*

1990’s the elaborate regime of credit ceilings introduced in

October, 1973 for individual banks to meet the credit needs of the private sector, and later on of PSEs also, continued till end-June, 1992, although by this time a number of reform measures had already been taken to initiate the transition from administrative fiat to a market-oriented approach. The system of credit ceilings was replaced with the somewhat flexible system of credit deposit ratio (CDR) with effect from 1st of August, 1992. Various reforms continued during this phase (1992-93 to 1994-95), culminating in the abolition of CDR itself on 30th September, 1995.

Monetary Policy(1990-2007)

UMER LATIF

1990’SOBJECTIVES TOOLS IMPACT

To implement the structural adjustment program of IMF & World Bank

Shift from credit ceiling, credit deposit ratio & indicative targets to OMOs

GDP growth = 3.8%Inflation = 9.71%Monetary Expansion = 15.28%

2000-2005OBJECTIVES TOOLS IMPACT

To ensure growth without giving much attention to price stability

Only OMOs and discount rates were used but the impact was negligible, because the SBP was completely under the influence of government

GDP growth = 5.23%Inflation = 5.46%Monetary Expansion = 15.1%

2006OBJECTIVES TOOLS USED IMPACT

The objective is to use OMO to drained excess liquidity from the inter-bank market without bringing any significant change in the benchmark 6-month T-bill rate.

SBP tightened the monetary policy by using:•Open Market Operation•Discount rate increases•CRR =7 % on demand liab and 3% on time liab.•Statutory Liquidity Requirement (SLR)= 18%

GDP Growth = 5.8%

Inflation = 7.92%

Monetary = 15%Expansion

2007OBJECTIVES TOOLS USED IMPACT

The objective is to achieve balancing growth and price stability growth by ensuring effective liquidity management as well as providing adequate and timely concessional credit to priority sectors.

SBP continued to implement its tight monetary stance during FY07 through effective utilization of OMOs. The frequency of OMO in FY07 is down as compared to FY06 mainly due to the better liquidity forecasting of SBP.

GDP Growth = 6.8% Inflation = 7.77% Monetary = 19.3%Expansion

Monetary Expansion Trend

0

5

10

15

20

25

30

1950's 1960's 1970's 1980's 1990's 2000-2005

Decades

Mon

etar

y Gr

owth

Rat

es Series1

Series2

Series3

Money Supply, Inflation and Economic Growth: Issues in Monetary Management in PakistanM. Ashraf Janjua*

Inflation Trend

02468

10121416

1950's 1960's 1970's 1980's 1990's 2000-2005

Decades

Infla

tion

Rate

s Series1

Series2

Money Supply, Inflation and Economic Growth: Issues in Monetary Management in PakistanM. Ashraf Janjua*

Monetary Policy(2008 to 2011)

MOHAMMAD FARHAN ALI KHAN YOUSAFZAI

YEAR OBJECTIVES TOOLS USED IMPACT

2008

The objective is to launch a comprehensive macroeconomic stabilization package for the medium term which aimed to curb the growing macroeconomic imbalances and strengthen the fiscal and monetary coordination.Tightening of Monetary policy and balance tradeoff between growth and price stability

•Explicit ceilings on government borrowings from SBP.•Increase in the SBP policy discount rate by 150 bps to 12.0 percent.•Increase in the Cash Reserve Requirement (CRR) And Statutory Liquidity Requirement (SLR) •all Banks are required to pay a minimum profit rate of 5 percent of Saving/PLS saving products

GDP Growth = 5.8%

Inflation = 12.0%

Monetary Expansion = 15.4%

YEAR OBJECTIVES TOOLS USED IMPACT

2009

The objective is to strike a balance between stabilization and sustainable recovery in an environment, to keep the weighted average overnight repo rate stable and close to the policy discount rate.

SBP has decided to cut the policy rate by 100 basis points to 13 percent The other tools that are only sparingly used include changes in Cash Reserve Requirements (CRR), Statutory Liquidity Requirements (SLR), and foreign exchange swaps.

GDP Growth = 2.0% Inflation = 20.77% Monetary Expansion = 9.0%

YEAR OBJECTIVES TOOLS USED IMPACT

2010

The objective is to reinforce the need for serious policy efforts to achieve sustained high growth.

SBP increased the policy rate in the first half of the fiscal year by 50 basis points to 13.5% Subsequent use of OMO.

GDP Growth = 3.0% Inflation = 11.29% Monetary Expansion= 5.7%

http://www.sbp.org.pk/m_policy/MPD-Sep-2010-Compendium.pdf

In recent years, the issue of central bank independence has also been brought to limelight and, consequently, many countries have granted independence to their respective central banks in their policy formulations. (Nordhaus: 1994). However, the degree of independence varies among countries varying from Germany where central bank is totally independent to Japan where central bank is accountable to finance ministry.

Countries whose policies are not co-coordinated may suffer from high deficits and inflationary pressures. Fiscal authorities, with the objective to be re-elected, are reluctant to decrease spending and hence may cause high budget deficit that may leads to inflationary pressures. Monetary authorities, on the other hand have a harsher stance on deficit and inflation (Bartolomeo and Gioacchino: 2008).

In 1997, government

issued three

Amendment Ordinances

these changes gave full

and exclusive authority

to the SBP to regulate

the banking sector, to

conduct an independent

monetary policy and to

set limit on government

borrowings from the

SBP.

Rs 1171 billion (on cash

basis) as on 30th June

2010

SBP LOSING AUTONOMY

http://www.sbp.org.pk/m_policy/MPD-30-Jul-10(English).pdf

http://www.sbp.org.pk/m_policy/MPD-30-Jul-10(English).pdf

RESERVES

SBP’s net foreign exchange reserves improved from $9.1 billion at end-June 2009 to $13.0 billion at end-June 2010

large repayments of IMF loans from beginning in FY12

http://www.sbp.org.pk/m_policy/MPD-30-Jul-10(English).pdf

The September 2010 policy decision can be called an announcement.

SBP has no control and is more like a colonial currency boardMr Javed Ansari in his article mentions the Monetary

statements are always lengthy and January 2010 was over 20,000 words which had detailed analysis of monetary policy and its justification.

Inflationary pressure have not been reduced and CPI has increased from 8.9% in Oct ‘09 to 13.2% in Feb ‘10. food inflation has also doubled

Ineffectiveness of M.P is clear but SBP shifts its blame to Federal ministry of finance due to fiscal uncertainty

Blames government for Inflation as electricity and wheat price increase.

Criticisms

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.

To conclude it can be said that with the passage of time the SBP has lost its autonomy, and gave more attention to the government’s agenda of high growth at the cost of high inflation. The SBP should conduct its monetary policy independently keeping in view its main objective of price stability.

What needs to be done