INSTITUTE OF BUSINESS AND TECHNOGY

ROLE OF STATE BANK IN MONETARY POLICY

1. INTRODUCTION
Introduction: In the beginning of the report, I focused the State Bank functions, departments and responsibilities towards the Economy and the relationship with Government of Pakistan.The State Bank of Pakistan also performs both the traditional and developmental functions to achieve macroeconomic goals. The traditional functions, may be classified into two groups, i.e. Primary and Secondary. Being the Central Bank of the country, State Bank of Pakistan has been entrusted with the responsibility to formulate and conduct monetary and credit policy in a manner consistent with the Governments target. Along with State Bank detailed introduction, the report also includes the brief introduction of Monetary policy, its types, tools and instruments, objectives, intermediates targets and its limitations. Monetary policy management and financial sector stability are two primary roles of State Bank of Pakistan (SBP). Monetary policy and process of its formulation in Pakistan has undergone changes with the evolving economic dynamics within the country and the improved empirical and theoretical understanding of the monetary policy across the world. In the middle the report contains the Role of State Bank in Monetary Policy, which includes the transparency in making, transmission, controlling, and comparison with other Central Banks. This report also contains the SBP response through Monetary Policy 2008, the issues which State Bank faced, the what Risks and Challenges are involve, and the measure the SBP has taken along with Implication and Limitations. Apart from the SBP own analysis, this report also contains the Independent (external) Analysis, which based on secondary statical data and various economists views. In the last part, the 4rth chapter supplemented to discuss the current scenario of Global Financial Crisis, how the State Bank encounters this turmoil by interim issue of monetary policy statements, the measures taken to improve Liquidity and restore stability in the money market and exchange rate. Finally the last chapter it includes the overall Recommendation with Conclusion.

1.2 Purpose of Study: The purpose of this report is to get the knowledge about the Role of State Bank of Pakistan in Monetary Policy. Because being the student of MBA banking & finance I should have the complete idea about the Central Bank of the Country and its role in the Monetary Policy Management. Why monetary Policy? Because monetary policy is the major driving force for financial institutions, money market, capital market as well as the Economic and Financial stability of the country. What is the driving force to choose the monetary policy for the project report? Because I am the full time student and not the part of any formal organization but my father work for State Bank and just because of him I could easily access to Monetary Policy Division of SBP and its personnel directly. Basically the purpose of this study is to understand that how central bank formulate, implementation (transmission) of Policy, the challenges and risk are involve, and how they use their different tools in varied economic conditions. Apart from these, in the light of external analysis about what those factor which creates trouble for them after taking all preventive measures and projections for future. Secondly the how global crunch is affecting Pakistan, the proactive approach which state bank adopted to restore the exchange rate, control inflation, stability of Financial Institutions, liquidity and ultimately the overall macroeconomic growth. Unfortunately the monetary policy in Pakistan had long remained dormant to play its true role in macroeconomic management and was made hostage to fiscal policy to give coverage to persistent fiscal indiscipline. Abstracting from the little discussion of emerging complications for Asia, I propose to now concentrate on Pakistan.

1.3 Research Objective: There are following research objectives listed on the basis of priority. Independence and Transparency Analysis of State Bank of Pakistan in comparison with other Central Banks. Global Financial Crisis and State Banks measures, with recommendations. Functions and Responsibilities of State Bank of Pakistan. Monetary Policy?

1.4 Research Methodology: We employ the Eijffinger and Geraat (2007) independent analysis approach to measure monetary policy transparency of the State Bank of Pakistan. According to this approach, a questionnaire (see Appendix A) is developed on monetary policy issues and the researcher independently answers the questions based on information gleaned from various central bank documents like reports on the state of the economy, monetary policy statements, and speeches of the central bank officials. The questionnaire elicits information through a set of fifteen questions, with three questions each on political, economic, procedural, policy and operational transparency. Each question has two or three options with a maximum score of 1. In case of two options the central bank is awarded either 0 or 1 score but in case of three options there is a middle score of 0.5 (a case of partial transparency). In aggregating the score, all the questions are given equal weight so on each aspect of transparency a central bank can get a maximum score of 3. Each type of transparency is also given the same weight so there is no preference for one type of transparency over the other. In this way a central bank can get a maximum score of 15. There are at least three important advantages of using the Eijffinger and Geraats (2007) index. First, unlike survey-based techniques, this index is based on an independent analysis (by the researcher) of monetary policy practices. This is important because in surveys, respondents (central bankers) may have an incentive to falsely portray a favorable scenario of monetary policy transparency. Second, the index covers almost all the aspects of monetary policy and hence presents a broader measure of transparency as compared with other works that have focused on only two or three aspects. Third, the index is not restricted to any particular type of monetary policy framework e.g. inflation targeting, monetary targeting etc.

2. STATE BANK OF PAKISTAN

2.1 Introduction to Central Bank: It is a bank, which is responsible for the financial and economic stability of country. The bank is a symbol of its sovereignty and solidarity. Every country, whether developed or not, capitalist or otherwise must have a central bank. It has a pivotal position in the banking system and regulates and formulates policies for the scheduled commercial banks in a country. In Pakistan the central bank is known as State Bank of Pakistan. The Origin of central banking system can be traced back to 1694 when the Bank of England came into being as the first ever central bank. In the beginning the central bank was mainly confined only to issuing paper currency, but at later stages it was entrusted with other crucial functions like credit control, clearing house management of public debts, rediscounting of bills, custodian of foreign exchange, and the like. Now a central bank has become a must for every country and its economy. It control other banks, DFIs, inflation, formulates economic, Fiscal and monetary policy and advises the government on foreign trade, development of financial and capital markets, balance of trade, foreign aids etc. The world has turned into a global village, every country being increasingly dependent on one another. Consequently, it has not only augmented the role of a central bank but also necessitated the establishment of a world central bank that regulates the function of all central banks under the sun. Hence, the World Bank (IBRD) and International Monetary Fund (IMF) have come into being exercising their full control all central bank, especially those in the Third World Countries. Even, an international currency named Special Drawing Rights (SDR) has been evolved. Every country, being the member of the UN, has no option except to follow the dictates of the IMF and the World Bank.
History:

The State Bank of Pakistan (SBP) (Urdu: ) is the central bank of Pakistan. While its constitution, as originally laid down in the State Bank of Pakistan Order 1948, remained basically unchanged until January 1, 1974, when the bank was nationalized, the scope of its functions was considerably enlarged. The State Bank of Pakistan Act 1956, with subsequent amendments, forms the basis of its operations today. The headquarters are located in the financial capital of Pakistan, Karachi with its second headquarters in the capital, Islamabad. Before independence on 14 August 1947, the Reserve Bank of India (central bank of India) was the central bank for what is now Pakistan. On 30 December 1948 the British Government's commission distributed the Bank of

India's reserves between Pakistan and India - 30 percent (750 M gold) for Pakistan and 70 percent for India. The losses incurred in the transition to independence were taken from Pakistan's share (a total of 230 million). In May, 1948 Muhammad Ali Jinnah (Founder of Pakistan) took steps to establish the State Bank of Pakistan immediately. These were implemented in June 1948, and the State Bank of Pakistan commenced operation on July 1, 1948 Muhammad Ali Jinnah on 1st July 1948 at the opening of the State Bank of Pakistan Under the State Bank of Pakistan Order 1948, the state bank of Pakistan was charged with the duty to "regulate the issue of bank notes and keeping of reserves with a view to securing monetary stability in Pakistan and generally to operate the currency and credit system of the country to its advantage". A large section of the state bank's duties were widened when the State Bank of Pakistan Act 1956 was introduced. It required the state bank to "regulate the monetary and credit system of Pakistan and to foster its growth in the best national interest with a view to securing monetary stability and fuller utilisation of the countrys productive resources". In February 1994, the State Bank was given full autonomy, during the financial sector reforms. On January 21, 1997, this autonomy was further strengthened when the government issued three Amendment Ordinances (which were approved by the Parliament in May 1997). Those included were the State Bank of Pakistan Act, 1956, Banking Companies Ordinance, 1962 and Banks Nationalisation Act, 1974. These changes gave full and exclusive authority to the State Bank to regulate the banking sector, to conduct an independent monetary policy and to set limit on government borrowings from the State Bank of Pakistan. The amendments to the Banks Nationalisation Act brought the end of the Pakistan Banking Council (an institution established to look after the affairs of NCBs) and allowed the jobs of the council to be appointed to the Chief Executives, Boards of the Nationalised Commercial Banks (NCBs) and Development Finance Institutions (DFIs). The State Bank having a role in their appointment and removal. The amendments also increased the autonomy and accountability of the chief executives, the Boards of Directors of banks and DFIs. The State Bank of Pakistan also performs both the traditional and developmental functions to achieve macroeconomic goals. The traditional functions, may be classified into two groups: The primary functions including issue of notes, regulation and supervision of the financial system, bankers bank, lender of the last resort, banker to Government, and conduct of monetary policy. The secondary functions including the agency functions like management of public debt, management of foreign exchange, etc., and other functions like

advising the government on policy matters and maintaining close relationships with international financial institutions. The non-traditional or promotional functions, performed by the State Bank include development of financial framework, institutionalisation of savings and investment, provision of training facilities to bankers, and provision of credit to priority sectors. The State Bank also has been playing an active part in the process of islamisation of the banking system. 2.2 Fundamental & Core Functions: The functions of a central bank can be placed in two broad categories: 1) Governments Bank. 2) Bankers Bank. As a governments bank, the central bank performs the following functions: 1. Monopoly of note issue. 2. Controller of Credit. 3. Custodian of Foreign exchange. 4. Issue and Management of Public debts. 5. Development of financial institutions. 6. Implementing Monetary Policy The central banks also act as bankers bank. In this capacity it performs valuable services to its scheduled commercial banks. These indispensable services are as under. 1. Lender of the resort. 2. Rediscounting of the bill of exchange. 3. Clearing House Services. 4. Cash Reserves. 5. Counseling Services. 6. Regulating and Supervising the Banking Industry.
Core Functions of State Bank:

State Bank of Pakistan is the Central Bank of the country. While its constitution, as originally laid down in the State Bank of Pakistan Order 1948, remained basically unchanged until 1st January 1974 when the Bank was nationalized, the scope of its functions was considerably enlarged. The State Bank of Pakistan Act 1956, with subsequent amendments, forms the basis of its operations today. Under the State Bank of Pakistan Order 1948, the Bank was charged with the duty to "regulate the issue of Bank notes and keeping of reserves with a view to securing monetary stability in Pakistan and generally to operate the currency and credit system of the country to its advantage". The scope of the Banks operations was considerably widened in the State Bank of Pakistan Act 1956,

which required the Bank to "regulate the monetary and credit system of Pakistan and to foster its growth in the best national interest with a view to securing monetary stability and fuller utilization of the countrys productive resources". Under financial sector reforms, the State Bank of Pakistan was granted autonomy in February 1994. On 21st January 1997, this autonomy was further strengthened by issuing three Amendment Ordinances (which were approved by the Parliament in May, 1997) namely, State Bank of Pakistan Act, 1956, Banking Companies Ordinance, 1962 and Banks Nationalization Act, 1974. The changes in the State Bank Act gave full and exclusive authority to the State Bank to regulate the banking sector, to conduct an independent monetary policy and to set limit on government borrowings from the State Bank of Pakistan. The amendments in Banks Nationalization Act abolished the Pakistan Banking Council (an institution established to look after the affairs of NCBs) and institutionalized the process of appointment of the Chief Executives and Boards of the nationalized commercial banks (NCBs) and development finance institutions (DFIs), with the Sate Bank having a role in their appointment and removal. The amendments also increased the autonomy and accountability of the Chief Executives and the Boards of Directors of banks and DFIs. Like a Central Bank in any developing country, State Bank of Pakistan performs both the traditional and developmental functions to achieve macro-economic goals. The traditional functions, which are generally performed by central banks almost all over the world, may be classified into two groups: (a) the primary functions including issue of notes, regulation and supervision of the financial system, bankers bank, lender of the last resort, banker to Government, and conduct of monetary policy, and (b) the secondary functions including the agency functions like management of public debt, management of foreign exchange, etc., and other functions like advising the government on policy matters and maintaining close relationships with international financial institutions. The nontraditional or promotional functions, performed by the State Bank include development of financial framework, institutionalization of savings and investment, provision of training facilities to bankers, and provision of credit to priority sectors. The State Bank also has been playing an active part in the process of islamization of the banking system. The main functions and responsibilities of the State Bank can be broadly categorized as under. 2.3 Responsibilities
Regulation of Liquidity

Being the Central Bank of the country, State Bank of Pakistan has been entrusted with the responsibility to formulate and conduct monetary and credit policy in a manner consistent with the Governments targets for growth and inflation and the recommendations of the Monetary and Fiscal Policies Coordination Board with respect to macro-economic policy objectives. The basic objective underlying its functions is two-fold i.e. the maintenance of monetary

stability, thereby leading towards the stability in the domestic prices, as well as

the promotion of economic growth. To regulate the volume and the direction of flow of credit to different uses and sectors, the Bank makes use of both direct and indirect instruments of monetary management. Until recently, the monetary and credit scenario was characterized by acute segmentation of credit markets with all the attendant distortions. Pakistan embarked upon a program of financial sector reforms in the late 1980s. A number of fundamental changes have since been made in the conduct of monetary management, which essentially marked a departure from administrative controls and quantitative restrictions to market-based monetary management. A reserve money management program has been developed. In terms of the program, the intermediate target of M2 would be achieved by observing the desired path of reserve money - the operating target. While use in now being made of such indirect instruments of control as cash reserve ratio and liquidity ratio, the programs reliance is mainly on open market operations.
Ensuring the Soundness of Financial System

One of the fundamental responsibilities of the State Bank is regulation and supervision of the financial system to ensure its soundness and stability as well as to protect the interests of depositors. The rapid advancement in information technology, together with growing complexities of modern banking operations, has made the supervisory role more difficult and challenging. The institutional complexity is increasing, technical sophistication is improving and technical base of banking activities is expanding. All this requires the State Bank for endeavoring hard to keep pace with the fast-changing financial landscape of the country. Accordingly, the out dated inspection techniques have been replaced with the new ones to have better inspection and supervision of the financial institutions. The banking activities are now being monitored through a system of off-site surveillance and on-site inspection and supervision. Off-site surveillance is conducted by the State Bank through regular checking of various returns regularly received from the different banks. On other hand, on-site inspection is undertaken by the State Bank in the premises of the concerned banks when required. To deepen and broaden financial markets as also to diversify the sources of credit, a number of non-bank financial institutions (NBFIs) were allowed to increase substantially. The State Bank has also been charged with the responsibilities of regulating and supervising of such institutions. To regulate and supervise the activities of these institutions, a new Department namely, NBFIs Regulation and Supervision Department was set up. Moreover, in order to safeguard the interest of ultimate users of the financial services, and to ensure the viability of institutions providing these services, the State Bank has issued a

comprehensive set of Prudential Regulations (for commercial banks) and Rules of Business (for NBFIs). The "Prudential Regulations" for banks, besides providing for credit and risk exposure limits, prescribe guide lines relating to classification of short-term and long-term loan facilities, set criteria for management, prohibit criminal use of banking channels for the purpose of money laundering and other unlawful activities, lay down rules for the payment of dividends, direct banks to refrain from window dressing and prohibit them to extend fresh loan to defaulters of old loans. The existing format of balance sheet and profit-and-loss account has been changed to conform to international standards, ensuring adequate transparency of operations. Revised capital requirements, envisaging minimum paid up capital of Rs.500 million have been enforced. Effective December,1997, every bank was required to maintain capital and unencumbered general reserves equivalent to 8 per cent of its risk weighted assets. The "Rules of Business" for NBFIs became effective since the day NBFIs came under State Banks jurisdiction. As from January 1997, modarbas and leasing companies, which are also specialized type of NBFIs, are being regulated/supervised by the Securities and Exchange Commission (SECP), rather than the State Bank of Pakistan.
Exchange Rate Management & Balance of Payment

One of the major responsibilities of the State Bank is the maintenance of external value of the currency. In this regard, the Bank is required, among other measures taken by it, to regulate foreign exchange reserves of the country in line with the stipulations of the Foreign Exchange Act 1947. As an agent to the Government, the Bank has been authorized to purchase and sale gold, silver or approved foreign exchange and transactions of Special Drawing Rights with the International Monetary Fund under sub-sections 13(a) and 13(f) of Section 17 of the State Bank of Pakistan Act, 1956. The Bank is responsible to keep the exchange rate of the rupee at an appropriate level and prevent it from wide fluctuations in order to maintain competitiveness of our exports and maintain stability in the foreign exchange market. To achieve the objective, various exchange policies have been adopted from time to time keeping in view the prevailing circumstances. Pak-rupee remained linked to Pound Sterling till September 1971 and subsequently to U.S. Dollar. However, it was decided to adopt the managed floating exchange rate system w.e.f. January 8, 1982 under which the value of the rupee was determined on daily basis, with reference to a basket of currencies of Pakistans major trading partners and competitors. Adjustments were made in its value as and when the circumstances so warranted. During the course of time, an important development took place when Pakistan accepted obligations of Article-VIII, Section 2, 3 and 4 of the IMF Articles of Agreement, thereby making the Pak-rupee convertible for current international transactions with effect from July 1, 1994.

After nuclear detonation by Pakistan in 1998, a two-tier exchange rate system was introduced w.e.f. 22nd July 1998, with a view to reduce the pressure on official reserves and prevent the economy to some extent from adverse implications of sanctions imposed on Pakistan. However, effective 19th May 1999, the exchange rate has been unified, with the introduction of market-based floating exchange rate system, under which the exchange rate is determined by the demand and supply positions in the foreign exchange market. The surrender requirement of foreign exchange receipts on account of exports and services, previously required to be made to State Bank through authorized dealers, has now been done away with and the commercial banks and other authorized dealers have been made free to hold and undertake transaction in foreign currencies. As the custodian of countrys external reserves, the State Bank is also responsible for the management of the foreign exchange reserves. The task is being performed by an Investment Committee which, after taking into consideration the overall level of reserves, maturities and payment obligations, takes decision to make investment of surplus funds in such a manner that ensures liquidity of funds as well as maximizes the earnings. These reserves are also being used for intervention in the foreign exchange market. For this purpose, a Foreign Exchange Dealing Room has been set up at the Central Directorate of State Bank of Pakistan and services of a Forex Expert have been acquired. 2.4 Developmental Role of State Bank The responsibility of a Central Bank in a developing country goes well beyond the regulatory duties of managing the monetary policy in order to achieve the macro-economic goals. This role covers not only the development of important components of monetary and capital markets but also to assist the process of economic growth and promote the fuller utilization of a countrys resources. Ever since its establishment, the State Bank of Pakistan, besides discharging its traditional functions of regulating money and credit, has played an active developmental role to promote the realization of macro-economic goals. The explicit recognition of the promotional role of the Central Bank evidently stems from a desire to re-orientate all policies towards the goal of rapid economic growth. Accordingly, the orthodox central banking functions have been combined by the State Bank with a well-recognized developmental role. The scope of Banks operations has been widened considerably by including the economic growth objective in its statute under the State Bank of Pakistan Act 1956. The Banks participation in the development process has been in the form of rehabilitation of banking system in Pakistan, development of new financial institutions and debt instruments in order to promote financial intermediation, establishment of Development Financial Institutions (DFIs), directing the use of

credit according to selected development priorities, providing subsidized credit, and development of the capital market.
Structure and Operations:

The central directorate of the bank is situated in Karachi. The bank is empowered to establish branches, offices and agencies in Pakistan or, with the prior approval of the federal government, anywhere out side Pakistan. The bank started with only a nucleus organization but its organizational structure has grown rapidly. Apart from the central directorate, there are several offices, which function under the general guidance and supervision of the Central Directorate. In 2001 SBP established a subsidiary, the banking service corporation to oversee the banking systems and provide supervision and support services. The general superintendence and direction of the affairs and business of the bank (and its subsidiary) is vested in a Central Board of Directors comprising of Governor, Deputy Governors and Directors nominated by the federal government. With the expectation of the government directors, no person can be a director who is the member of federal and provincial legislature, who is salaried government official, who is an officer or employee of any bank, who is a director of another bank, or who absents himself from three consecutive meetings of the Central Board without leave. The directors hold office at the pleasure of the federal government. Meetings of the Central Board are required to be held at least six times year and at least once every quarter. The Chief Executive of the Bank is the governor who controls and directs the affairs of the bank on the behalf of the Central Board. S(he) has full authority to conduct the business control the functions and manage the affairs of the bank in all matters not specifically required by the act, or by regulation made their under, to be conducted by the Central Board. The governor appointed by the federal government for a term not exceeding five years and on such salary and terms and conditions of service as the federal government may determine. His salary and other terms and conditions of service cannot be varied to his disadvantage after appointment. He is also eligible for reappointment, if the government so desires, on the completion of his term of office. The governor presides at the meetings of the central board. Deputy Governors are also appointed by the federal government for a period not exceeding five years. There terms and conditions of service cannot be varied to their disadvantage after their appointment. The Deputy Governors performs such duties as a assigned to them by the central Board and, in the absence of governor, a deputy governor presides at the meetings of the central board and transacts all business of the bank. Most State Bank governors have held five year terms. Dr. Yaqub Architect of the marketization of national monetary policy was appointed in 1993 and his term of office was prematurely extended in 1997 by the pro-IMF caretaker administration of Mr. Mooeen Qureshi. Dr. Yaqub resigned in 1999. executive directorships

were established in 1965. The executive directors are not director of the board but share work with the deputy governor. The co-ordination committee was also setup which was the highest policy making body at the executive level. In recent years, the co-ordination has become non-functional. External advisors especially those nominated by the IMF have acquired increased influence as have non-line advisors appointed by the governor. The State Banks operational and organizational structure has been consciously modeled on that of the bank of England. It has two nationally separate departments (the issue departments and the banking department). The later transacts general banking business, while the former is concerned exclusively with the issue of notes. As of 1 June 2002, there were two deputy governors, a chief economic advisor to governor, five other advisors to he governor, three executive directors, and eighteen department heads. The banking services corporation is headed by a managing director and has eight departments a sixteen field offices (previous regional offices of the SBP). State bank was the sole authority for the issue of notes. Until 1965, it was responsible for coins and Rs 1 notes which is now the concern of the federal government. Under the state bank of Pakistan act 1956, the issue of notes was bases on proportional reserve system. The entire amount representing the notes issued had to be backed by an equivalent amount of assets of which not less than 30% was required to be maintained in the form of gold coins, gold bullion, Silver bullion, and approved foreign exchange. The assets were required to be held in the form of rupee coins, rupee securities, and such bills of exchange and promissory notes as were eligible for purchase by the bank. The requirement relating to the maintenance of minimum amount of gold coin, gold and silver bullion, and approved foreign exchange could, however, be suspended by the bank with previous sanctions of federal government, for a period not exceeding 20 days in first instance which could be extended from time to time by the period not exceeding fifteen days. There was only one occasion on which provision of suspension was resorted to during the 1965 Indo-Pakistan War. The State Bank also acts as banker or to federal and provincial governments. They are required to deposit, free of interest, their cash balances with the bank which accept government deposits and cheques or drafts, undertakes the collection of these cheques and drafts drawn on other bank, and provides cash to them. It debits their accounts with amount of cheques or voucher drawn by the government on the state bank presented for encashment by other parties. It transfers government funds and manages the public debt of the federal as well as the provincial governments. In places where it does not have its own office, the state bank has appointed the National Bank of Pakistan as its agents to conduct government business. It charges no commission from the government for services rendered and it pays no interest to the government on their balances. The work relation to the government accounts is handled in the public accounts department of the state bank. Apart from the issue of permanent public debt, the

bank also sells government treasury bills on tap or tender and National Prize Bonds. The bank makes advances to the federal as well as the provincial governments, which are repayable not latter than three month. These advances are made with out collateral security. In addition, loans are also guaranteed to provincial governments against collateral of federal government securities. The state bank fixes limits for such advances from time to time. The bank enjoys certain powers permitting it in special circumstances to relax usual requirements regarding the securities to be lodged by the banks for borrowing from it, and can provide accommodation to them against any security which to consider sufficient. In such special circumstances, the bank can also dispense with the requirement of providing loans and discount facilities through scheduled banks, although in the normal conduct of business it is debarred from having such dealings. The state bank is prohibited from undertakings the following business: a) To engage in trade or otherwise have direct interest in any commercial, industrial, or other undertaking except such interest as it may in any way acquire in the course of the satisfaction of any of its claims but also such interest shall be disposed of at the earliest possible moments; b) To purchase its own shares or the shares of any other bank or company or grant advances or loans upon the security of any such shares; c) To advances money on the mortgage or on the security of immoveable property or documents of titles relating thereto; d) To become the owner of any immoveable property except where ownership is necessary for the use of the Bank; e) To make unsecured advances or loans; f) To draw or accept bills payable otherwise than on demand. The bank collects comprehensive statistical information on money and banking, balance of payments, foreign investment and other allied subjects. It issues a weekly press communiqu on the affairs of the scheduled banks and also a weekly statement of its own affairs, which is statuary responsibility. It also published a monthly bulletin and Annual report. There is a research department, an economic policy department and a statistics department but research output is poor compared to that of Reserve Bank of India. The state has yet to be publish an economy wide flow of funds table and its analysis of corporate balance sheet data is usually four years out of date. Much of research undertaken by the State Bank is now geared to serving the primary data needs of the IMF and World Bank resident missions and is thus of a classified nature-not generally available to Pakistani Policy-makers and students.

2.5 Relationship with the Government

Formally the government exercise comprehensive control over the State Bank. The government appoints both the Governor and Deputy Governors. The government nominates all the directors who serve on the Central Board, including one from among its officials. If in its opinion, the bank fails to carry out any of the obligations imposed on it, the federal government may, by notification declare the central board to be superseded and thereafter the general superintendence and direction of the affairs of the bank may be entrusted to such agency as the federal government may determine. In such an event, the federal government would be obliged to make full report of the circumstances leading to such action to be laid before the National Assembly. The federal government is also empowered to remove the Governor or Deputy Governors from office if their continuance in office as regarded as manifestly opposed to the interests of the Bank. Under section 44 of the State Bank of Pakistan Act (1956 as amended). The federal Government may, at any time appoint the Auditor General or such Auditors as it thinks fit examine and report upon the accounts of the bank. However, in the normal circumstances the terms and condition of service of the Governor and the Deputy Governor cant be changed to their disadvantage once they are appointed. Once appointed, they cannot be removed from during their tenure except on conditions specially set out in the Act. Since 1988 there has been increasing pressure on the government to recognize and enhance the autonomy of the Central Bank. The essence of this autonomy lies in the placing of limitations on the government to: Manage foreign exchange. This means accepting priorities of the international money markets and adjusting the national macro-economy to these preferences; Borrow from the Banking System as a whole; Borrow from the central Bank. Fixing targets for the government borrowing from the banking system has approved more difficult than limiting the governments borrowing from the State Bank.

3. STATE BANKS IN MONETARY POLICY

3.1 Monetary Policy Monetary policy is a short-run tool used by the central bank to persist sustainable economic growth (in the long-run) by controlling the money supply through open market operations, discount lending and reserve requirements. Before focusing on the significance for and affects of monetary policy on the economy of the country, first we discuss what monetary policy is? And how it is used by the central bank? Monetary policy is the process of managing a nation's money supply to achieve specific goalssuch as constraining inflation, achieving full employment or more well-being. Monetary policy can involve setting interest rates, margin requirements, capitalization standards for banks or even acting as the lender of last resort or through negotiated agreements with other governments. A wide variety of policy systems are possible to conduct monetary policy operations, but in the current international scenario, we have two broad groups of countries: The first one is the group of those countries (like Hong Kong, Zambia, and China, etc.), whose monetary policies are focused primarily on the exchange rate. They either has exchange rates fixed to a major international currency (usually U.S. dollar) or in some kind of target band and monetary policy involve the management of that exchange rate. The second is the group of countries with floating exchange rates (like the United States of America, Japan, Pakistan and Australia, etc.) and monetary policy involves the management of short-term interest rates by central banks to pursue the macroeconomic objectives of the economy. The central bank uses monetary policy in two ways: that is contractionary monetary policy or expansionary monetary policy. The Central Bank designs Contractionary policy in order to constrain the growth of money (i.e. increasing inflation) and credit in the economy. This is done by an increase in interest rates and a decrease in bond prices, such that higher interest rates lead to lower levels of capital investments, and leading the demand for bonds (domestic) to rise. The appreciation of domestic currency causes exchange rate to rise so there would be an increase in the demand for domestic currency and fall in demand for foreign currency. Thus a higher exchange rate causes a decline in exports and the imports get dearer in the country. In the present international scenario, due to hike in inflation internationally, most of the countries adopted contractionary policy, like Pakistan recently has increased interest rate by 0.5 percent and set 10 percent short-term interest

rates, and it is expected that the Reserve Bank of Australia (RBA) would increase short-term interest rates from 6.25 percent to 6.50 percent. On the other hand Expansionary policy is used as a tool by the central bank to broaden the monetary base and credit in the economy by reduction in interest rates and increase in bond prices. The reduced interest rates attract capital investments and increased bond prices reduce its demand and the demand for foreign bonds to rise. The exchange rate also lowers down as a result of fall in the demand for domestic currency and a rise in demand for foreign currency leading currency to depreciate, resulting imports to decline and export to accelerate. In 1999, Ecuador adopted the expansionary monetary policy in, but failed to achieve the required economic growth.
Objectives of Monetary Policy

Price stability, Maintenance of full employment, and The economic prosperity and welfare of the people of the economy. Price stability, that is controlled price level, is the imperative condition for the constant economic growth, once accomplished leads to full employment and economic prosperity. Price stability develops investors confidence boosting investments, causing acceleration of economic activity and achievement of full employment. Thus, the significance of monetary policy is to achieve the inflation target (set by the central bank for required economic growth), and as a consequence, to accelerate strong and sustainable economic growth. Achievement of inflation target directs strong currency valuation in terms of other foreign currencies, resulting as favorable balance of payments.
Tools of Monetary Policy:

In order to attain the objectives discussed above, the central bank uses three tools: open market operations, the discount rate and reserve requirements. Open Market Operations: The most effective and major tool the central bank uses to affect the monetary supply in the economy is open market operations that is, the buying and selling of government securities (usually bonds or T-bills) by the central bank. If the central bank decides to increase monetary base in the economy it buys securities from the open market and pays for these securities by crediting the reserve amounts of banks involved in selling. This will increase the reserve amount the banks hold, such that banks have more money to lend, interest rates

my fall, leading to increase investment spending and as a result economic growth. Conversely, in order to tighten the monetary base in the economy, the central bank sell the government securities, as a result collect payments from banks by reducing their reserve accounts. Having less money in these reserve accounts the opportunity cost of lending money decline, such that interest rates may increase, resulting a drop of investment spending, that is the slow down of economic activity. The Discount Rate: the rate at which financial institutions may borrow funds for short-term directly from the central bank. When the central bank reduces the discount rate, financial institutions must pay to borrow from the central bank; financial institutions become more willing to borrow, to make more money available for lending to businesses and households at low interest rates. This would initiate more consumption and investment spending and generate economic activity in the economy. The reverse would be the effect in case of increased discount rate. Reserve Requirements: the proportion of the total assets that banks must hold in reserve with the central bank. Financial institutions only maintain a small portion of their assets as cash available for immediate withdrawal; the rest is invested in illiquid assets (like loans and mortgages). The monetary policy can be implemented by altering the proportion of these required reserves. Increasing the proportion of total assets to be held as liquid cash increases the amount of money available to banks as loanable funds, thus mean the broader monetary base in the economy, vice versa.
How does Monetary Policy affect the economy of a country?

After having discussed the objectives and tools of monetary policy, let us now talk about how policy affects the economy: Consumption, Saving and Investment: Changes in the real interest rates affect the demand for consumption and savings of the people and also change the investment pattern of the businesses. For instance, a reduction in real interest rate lowers the cost of borrowing, encouraging people to borrow in order to consume (durable items like, electronic items, automobiles etc.). Moreover stimulating banks willingness to lend more and investors to invest more, on the other side discourage saving, resulting to increase spending and aggregate demand. Lower real interest rates also make stocks and other such investments more desirable than bonds, resulting stock prices to rise. People are likely to increase their stock of wealth.

Foreign Exchange, Imports and Exports: Short-run changes lower interest rate result as currency depreciation, which means lower prices of home-produced goods selling abroad, making exports dearer and discourage imports, reducing the gap between imports and exports and having favorable balance of trade. Again this leads to higher aggregate spending on goods and services produced in the country. Output and Employment: The increase in aggregate demand for the output boosts up the production cycle; generating employment, as a result increase investment spending on the existing industrial capacity. Which accelerate the consumption further due to more incomes earned, thus attaining the multiplier effect of Keynes.
How does Monetary Policy affect Inflation?

Monetary policy affects inflation in two ways. First, affecting indirectly, if monetary policy able to achieve multiplier effect, it boosts up economic activity. Initiating labor and capital markets to raise outputs beyond there capacities and creating an upward pressure on wages, thus resulting inflation to rise (that is cost-push inflation). Thus there would be a trade-off between higher inflation and lower unemployment in the short-run which further accelerate inflation. As wages and prices start to rise they are hard to bring down back, stressing the need for early policy measures to be taken. Secondly, monetary policy can directly affect inflation via future expectations. Like if people expect the rise in prices in future, they persuade to increase in wages, which in turn affect the prices, resulting higher-inflation.
Limitations of Monetary Policy:

Changes in money supply are governed by three factors, viz., (a) the domestic private sector, (b) the government sector, and (c) the foreign sector. The influence of the private sector on money supply is reflected in loans to the private sector by banks and their investment in private securities. An increase in the volume of bank credit to the private sector or the banks' investment in private securities tends to increase money supply. The influence of the government sector on money supply is reflected in the loans from the State Bank and commercial banks to the government sector and their investments in government securities adjusted for the change in their cash balances with the State Bank. An increase in such credits and investments has the effect of directly increasing money supply and vice versa. As regards the cash balances of the central and provincial governments, a decline in their level increases money supply and vice versa/The counterpart funds, which represent the sale proceeds of commodities received under aid arrangements in Pakistan, also have an impact on the level of money supply. The commodities received as

aid are sold in the country and the money so realized is credited in a special account in the State Bank from which releases are made to the government primarily for financing development project. If the level of counterpart funds increases, reflecting an excess of accumulations over releases, it exercises a contractionary effect on money supply and vice versa. The third causative factor is the foreign sector, which includes the State Bank's holdings of gold and foreign assets and authorized dealers' balances. Whenever foreign exchange receipts exceed payments, and the level of foreign exchange reserves rises, there is a net addition to money supply. Conversely, when payments exceed receipts, and the foreign exchange reserves decline, It has a contractionary influence on money supply. This analysis of changes in the money supply shows that money supply in circulation and deposit money, are not regulated by the State Bank alone. The monetary assets vary in accordance with the causative factors. There are three broad ways of controlling the level of money supply. It can be reduced through (a) running down of foreign exchange reserves, (b) restriction of credit to the private sector, and (c) restriction of credit to the government sector. Similarly, if the objective is to step up the rate of monetary expansion, (a) building up foreign exchange reserves (b) expanding credit to the private sector, and (c) expanding credit to the government sector can attain it. Limitations on the effectiveness of monetary policy are thus of two types. They may arise because-as the Keynesians show--the elasticities are not right. The demand for real money is interest elastic and investment demand is interest inelastic so that an increase in money supply does not significantly enhance aggregate demand. Alternatively, monetary policy may be ineffective because of the powerlessness of the State Bank vis--vis (a) the domestic financiers (b) the government and (c) international money markets. Kaldor has argued forcefully that the central bank is merely an instrument of capitalist policy. It has no choice but to passively accommodate the preferences of profit maximizing private banks and to continue to act as the' lender of the last resort. World Bank literature bemoans the impotence of the central bank, vis--vis national government and rising levels of bank borrowings to finance the budget deficit. World Bank literature insists on the need to increase the autonomy of the State Bank but since this recommendation is seen as being one element in a push for macroeconomic liberalization, the autonomy the State Bank gains from the government is soon lost to the international money market. Liberalization envisages both current and capital account convertibility. This undermines the ability of the State Bank to control the movement of external reserves. It merely accommodates the domestic monetary system to the rhythm of the international money markets. Domestic interest rate structures and credit allocations reflect

the policy preferences of global capitalists. The growing impotence of the State Bank calumniates in its conversion into an imperialist currency board.
Conclusion:

The results show that mostly developing countries fail to attain the desired goals of monetary policy. The basic hurdles are the deep debt burdens on government, and inflation pressures. Like, Pakistan, although adopted tight monetary policy, stood at actual inflation rate of 7.7% (FY 2006-07), against the inflation target of 6.5% (in FY 07). However, the monetary policy plays effective role to control the money supply in economy in the short-run for a sustainable prosperous long-term growth of developed countries. 3.2 Monetary Policy Department of SBP Monetary Policy Department (MPD), one of the core departments of the State Bank, is responsible to provide candid feedback for monetary and exchange rate management and facilitates the Monetary Policy Committee (MPC) in monetary policy formulation and decision making process. The Department is primarily engaged in the following major activities which include:: Preparation of Monetary Policy Statement; Preparation of dossier/working papers for various Committees; ; Making projections for future inflation and economic outlook using Macroeconomic Model and Financial Programming Framework; Preparation of Monetary Surveys; Preparation of Annual Credit Plan; Periodic analysis of monetary and credit developments; Contribution to consultations with the IMF; Appraisal of world economy and financial developments; and Empirical research papers. The Department has been divided into the following Divisions:
Monetary Survey Division

The Division is responsible to provide information and objective analysis to the management for prudent policy decisions. The Division is also responsible for the preparation of weekly Monetary Surveys and its allied information; analysis of money & credit trends; identification of issues and concern; assessment of policy developments and provision of input to the internal & external stakeholders. The Division prepares Annual Credit Plan/working papers for NCCC meetings and serves as the NCCC secretariat. It also contributes in providing information and analysis to the MPC and the Monetary Policy Statement.
Policy Formulation Division

The Division provides intellectual, analytical and data support for monetary policy formulation and appraisal, and furnishes working papers and background material for the MPC, Monetary and Fiscal Policies Coordination Board (MFPCB), Economic Coordination Committee (ECC) and Investment Committee meetings, thereby contributing to the efficient conduct of monetary policy and macroeconomic management. The Division also contributes in the preparation of Monetary Policy Statement taking into account global and regional policy initiatives..
Macro Modeling Division

The Division has been assigned the responsibility to make predictive assessment regarding inflation and future outlook of the economy. The Division is engaged in the following prime activities. To make forecast for major economic indicators and to provide an 3independent assessment of the future outlook of the economy, Quarterly, and Annual Reports, To make forecast for major economic indicators on monthly basis as an input for policy decisions, and The quarterly updation of the medium-term forecast (current plus three years ahead) based on Financial Programming 3.3 Making Monetary Policy in Pakistan The recent widespread concern about galloping inflation in Pakistan raises an important question: who makes monetary policy in Pakistan? Monetary policy is the responsibility of the State Bank of Pakistans (SBP) Central Board. The board approves all measures pertinent to the conduct of monetary policy as it does in other fields within its mandate, such as exchange rate policy. The composition of the Central Board, a vital institution that touches the lives of 160 million people, is obviously important. However, a look at this composition reveals a disquieting picture. The Central Board of the SBP is comprised of its chairman, the governor, a bureaucrat from the ministry of finance, and seven directors, one from each province, nominated by the federal government who represent agriculture, banking and industrial sectors. While there is no doubt that some members of the Central Board are persons of high moral fiber and integrity, the presence of representatives of agriculture, banking and industry poses potential conflict of interest issues. A board member with prior knowledge of interest rate and exchange rate decisions, or any decision that affects his business, can use this confidential information to pecuniary benefit. Furthermore, given the special interests they represent, their views are probably not unbiased. Nor are these persons likely to be economists,

monetary specialists, or have a feel for how monetary policy is conducted. The presence of a bureaucrat on the board would seem to be of little benefit given their typically generalist background, unless it is a way of the ministry of finance to keep tabs on what is going on at the central bank. The fact that seven members of the board are appointed on the recommendation of government raises all kinds of doubts on the integrity and objectivity of the recommendation process. What is striking is that there appears to be no professional monetary economist in the Central Board. There is probably no economist at all, and, even if there is one, his views can be set aside by the majority. How the board can grasp the technicalities and nuances of conducting monetary policy and make sound decisions without expert input is beyond comprehension. Decisions on the stance and implementation of monetary policy, and the crucial issue of timing of policy actions, is too serious and complicated a business to be left to self-styled, arm-chair monetarists who work part-time. 3.4 Monetary Policy Transparency (Analysis) Monetary policy transparency involves the disclosure of information by the central bank relevant to the conduct of monetary policy and requires symmetric information between the central bank and the private economic agents. A transparent central bank cannot have superior information about the state of the economy, transmission mechanism, economic data, and institutional arrangements etc. It is important to note that transparency does not require perfect knowledge of the economy as both the central bank and the general public may have imperfect information regarding shocks to the economy. Complete transparency requires openness on every aspect of the policy making process from objectives/ultimate goals of monetary policy to quantitative targets, relative weights on each of the objectives and the functional form of the objective function, and from setting policy instrument to achieving ultimate goals. A transparent monetary policy entails several benefits. To begin with, transparency lies at the heart of central bank independence and accountability. Mishkin (2004) and Nijathaworn (2006) argue that transparency increases public support for central bank policies, which is essential for winning central bank independence. The increased independence requires accountability of the central bankers to the society, as it is necessary for the legitimacy of the monetary policy, [Goodhart, Hildebrand, Lipton, and Wyplosz (2001); Mishkin (2004); Briault, Haldane, and King (1997); Buiter (1999); and Geraats (2002b)]. However, accountability of the central bankers cannot be achieved if the public is not fully informed of the monetary policy-making process. In this way, transparency can be thought of as a complement to central bank accountability [Geraats (2002a)]. Second, transparency not only helps improve the efficiency of the central bank but also makes it costly for the central bank to deviate from societys preferences7 [Buiter (1999); Bernanke, et al. (1999); Blinder, et al. (2001); and Roll, et al. (1993)].

Third, increased transparency can help reduce uncertainty in financial markets thereby improving long-run growth prospects [Nijathaworn (2006); Poole, et al. (2002); Svensson (2003)]. Fourth, a high degree of transparency forces the central bank to adhere to the stated objective and targets, thus increasing the credibility of the central bank [Faust and Svensson (2001); Levin, et al. (2004)]. Monetary policy transparency holds particular significance for developing countries where misperceptions and lack of knowledge about monetary policy issues and outcomes are not uncommon. In this context, an important benefit of transparency is that it can educate the public about what monetary policy can and can not do and thus avoid unnecessary criticism on the central bankers [Svensson (2002)]. Another benefit of transparency for developing countries is the promotion of public dialogue on policy issues that can be instrumental in bringing central bank policies in line with societys preferences. Also, a transparent monetary policy is vital for enforcing fiscal discipline on governments that rely heavily on seignorage revenues to meet budgetary shortfalls. Finally, monetary policy transparency can allow the public to compare central bank performance with international best practices, and thus create public pressure for the adoption of such practices whenever the performance of the central bank falls short of internationally accepted benchmarks.
Q. HOW TRANSPARENT IS THE SBP? Political Transparency

According to Eijffinger and Geraats (2007), political transparency refers to the openness about monetary policy objectives, quantification of these objectives and institutional setting for interaction between government and the central bank. Formal Objectives: Pakistan is a developing country having multiple objectives of monetary policy. SBP has the dual mandate of maintaining price stability and promoting output growth along with other objectives like foreign exchange rate stability. There has been no clear prioritization of the objectives with shifting preferences between price stability and output growth. Monetary policy has been kept expansionary whenever inflation was under control and/or government was unable to provide fiscal stimulus. This was exactly the strategy in 2006-07. But as inflation reached a sufficiently high level, the SBP tried to contain it (like the contractionary actions taken in 2008 and are still in force). This behavior is clear from the statements given in SBPs monetary policy statements. Though the SBP clearly states its objectives, it does not provide an explicit statement on their prioritization. One may argue that prioritization is mentioned whenever required in monetary policy reports by the SBP and hence it is transparent in this regard. But we should keep in mind the objective of transparency i.e. less uncertainty about central banks actions. To reduce uncertainty about central bank actions it is necessary to have knowledge on central banks long-term objectives and their prioritization in case of multiple objectives. Though SBPs documents often spell out the intentions and

preferences of the bank for the near future (mostly for one year), these may change depending on the state of the economy. Also, the ex-post statements by the central bank are merely policy explanations that cannot be taken as furthering the objective of transparency. Therefore, one can say that the SBP is transparent on announcing the objectives but not on the issue of prioritizing the multiple and conflicting objectives. Consequently, it is awarded a half score on the issue of formal objectives (Figure 1). Quantification of the Targets: The announcement of targets reduces uncertainty faced by the economic agents in making economic decisions. The SBP announces one-year inflation and output targets but provides no information on medium term targets. However, the announcement of one-year targets is of little value to economic agents who make decisions on the basis of expectations about medium or the long run. Furthermore, as Geraats (2005a) points out, the short-term targets are just forecasts/projections rather than the targets in the conventional sense, as the lag with which monetary policy actions affect the outcome (inflation) is normally greater than one year. We, therefore, conclude that the objective of transparency (reducing uncertainty) is not achieved by announcing just the short-term targets, and hence the monetary policy in Pakistan is still deficient in this area justifying a zero score on this count (Figure 1).

Institutional Arrangement: The process of independence of SBP effectively started in July 1993. The SBP Act 1956 was amended by a bill passed in February 1994 making monetary policy the sole responsibility of the SBP. The Act was again amended in May 1997 to further strengthen the autonomy by entrusting the central board to determine and enforce the limits on credit by the SBP to the government. Subsequently, however, SBP autonomy was effectively compromised, first, by an ordinance in December 2000 authorizing the federal

government to direct the SBP to set up funds for specific purposes as well as to introduce specialized credit schemes and influence the balance sheet of the SBP, and then by delegating the authority to appoint the governor to the president. There are at least two other problems that effectively limit the autonomy of the SBP. First, the SBP governor is appointed for a renewable term of three years, and this makes the central bank vulnerable to political pressures. Second, as is clear from SBP quarterly reports and Monetary Policy Statements, the unexpected borrowing of the government from SBP continues while the degree of monetisation of the fiscal deficit remains uncertain. These problems notwithstanding, it must be acknowledged that the financial sector reforms of the 1990s have provided a modicum of autonomy to the SBP. Therefore, SBP is considered as partially transparent in terms of institutional arrangements, earning half a score (Figure 1).
Economic Transparency

Economic transparency refers to the release of economic information the central bank uses for monetary policy including the current state of the economy (data on key variables), policy model that is used for policy analysis and central banks internal forecasts. Economic Data: The data on money supply and inflation are available on a quarterly basis. Though GDP is compiled on an annual basis, as is the unemployment rate, some informal analysis in the form of indicators is provided in SBP quarterly reports. Capacity utilization is discussed, on quarterly basis, only for large-scale manufacturing and not for the whole economy. All in all, SBP is partially transparent on data publication and there is stillroom for improvement. Thus a half score is assigned to SBP on this account (Figure 2). Macroeconomic Model: I could not find any information from formal sources on whether or not the SBP uses a macroeconomic model. However I obtained informal information that SBP now has its own macroeconomic model. The fact remains that SBP has never explained how the SBPs internal forecasts are made and how does it conduct policy analysis. So the monetary policy is completely opaque on this issue in Pakistan and hence a 0 score is assigned (Figure 2).

Central Bank Internal Forecasts: SBP publishes quarterly forecasts both for inflation and output normally at quarterly frequency but there are some problems with these forecasts. First, these forecasts are available only for the short run (for one year) and not for the medium or the long run. The publication of forecasts reduces uncertainty in the markets and makes the central banks intentions more transparent only if the forecasts are at least for the medium term. Keeping in view the long lags required before the effect of policy instrument on outcomes materializes, these forecasts do not make any sense. Second, although the SBP explains rough indicators of forecasts, it does not provide information on how the quantitative forecasts are made. So forecast mechanism is absent in its reports as are the assumptions or policy instrument path these forecasts are conditioned on. Third, SBPs forecasts cannot be called internal forecasts. These are simple and rough projections that any organization can make. Internal forecasts help central bank analyze how the policy decisions on the instrument path change the inflation and/or output in the long run. From the societys point of view, internal forecasts are important not only because they give some idea about the future but also because they serve as an indication of the central banks intentions. These objectives cannot be achieved if the policy instrument path is missing from the process of forecasting. Finally, one of the objectives of transparency about forecasts is to raise awareness in the public about the seriousness of the central bank in achieving the announced objectives. If forecasts based on policy rate path are not close to the stated objectives then it is an indication of the deviation of central bank policy from that of announced one. In this case, academia and professionals outside the central bank may point out this. So the central banks would not like to involve in a policy setting that cannot produce forecasted results according to the stated objectives, if the public has information on the forecasts. The above discussion shows that the forecasts published in SBP reports do not serve as indicators of the central banks seriousness in achieving the objectives and cannot fulfill the objective of transparency in terms of affecting private sectors information. Thus monetary policy is not fully transparent in this area if we consider the objective of transparency, though it is transparent if we take the short run forecasts without specification of the assumption about policy instrument path. So the SBP is awarded half score as it is partially transparent in terms of forecasts publication. (Figure 2).
Procedural Transparency

Procedural transparency refers to the information on the way the decisions are made by the central bank. According to Eijffinger and Geraats (2007), this type of transparency involves explicitness on monetary policy strategy and minutes and voting records of monetary policy committees meetings. Explicit Strategy: Regarding explicitness on the monetary policy strategy in Pakistan there is not even a single statement about any type of rule in any of the

SBPs documents and it seems that monetary policy strategy is characterized by discretionary framework. For instance, in 2001 when inflation was well contained, SBP took expansionary stance but changed course to tame inflation in 2005 when it was quite high. Thus there is uncertainty about both the degree as well as the timing of the monetary authoritys leaning against the wind. It is not clear as to at what level of inflation and/or output gap the SBP will decide to react. Also, there is uncertainty about how much the policy instrument would change when there is deviation of output and/or inflation from the target. This is not surprising as the SBP has never claimed to follow any type of rule. So on the basis of this discussion it is concluded that SBP has no explicit monetary policy framework justifying a zero score. Minutes and the Voting Records: There is no tradition of releasing the minutes and the voting records of the policy committees meetings. Only decisions for changing the policy tools are announced after the policy meetings and nothing more than that. So the SBP is awarded zero score on both these counts. It is worth noting here that Procedural Transparency is the only area of monetary policy transparency where the SBP is completely opaque.
Policy Transparency

Policy transparency relates to the openness of monetary policy decisions. It involves prompt announcement of policy decisions (probably on the day of implementation), an explanation of policy decisions and disclosure of policy inclination or likely future actions. Prompt Announcement: Policy changes in instruments/tools (open market operations, discount (repo) rate etc.) are announced on the day of implementation. But we must be a bit careful here. The transparency on this issue involves the information on changes in the operating targets and not just on the policy tools. It is necessary because unless the public knows the operational target it cannot judge whether the action taken by the central bank is appropriate or not. The impact of policy tools on ultimate targets/objectives is transmitted through the formers effects on the operational and the intermediate targets. So the SBP is transparent on the inputs (policy tools) but not on the (intermediate) output (operational target). It is important to note that central banks cannot be said to have private information on the changes in policy tools, as other market players also have the same. To elaborate, suppose there is an open market operation, a change in the discount rate or in the reserve requirements; then commercial banks are involved in this process and thus have perfect information on these changes. What the commercial banks really do not know is the operational target of the central bank, for which these tools are being used. Looking at the SBP practice, it is not clear as to what is its operating target. Although the announced operational target of SBP is reserve money, it is argued in some studies that the bank instead targets short interest rate since the financial sector reforms in early 1990s. Besides uncertainty about this issue, the

SBP does not announce targets for either reserve money or the short interest rate. However, the policy decisions on targets for monetary aggregate (M2) are announced in the annual credit plan. It is important to note that the SBP does not provide information on the short-term changes whereas transparency here is concerned with policy decisions in every monetary policy committees meeting and not with the annual targets. Also, the target for M2 is not a target as such, rather it is just a projection that depends on the overall projection of the economy. This argument is reinforced by the actions of the SBP in achieving the target for M2, as this target has been missed frequently in the history. On the basis of absence of information on the operational target, SBP has been awarded zero score. Policy Explanation: SBP does provide some explanation when there is a policy change. For instance, when there was a change in required reserve ratio by the SBP for commercial banks, it explained the objectives and the likely effects of the policy change as well as the rationale for such a change. But it is important to note that these explanations are for the changes in the policy tools and not for the changes in the operational target of the SBP. Similarly, although the policy changes are explained, there is no tradition of explaining decisions in every policy committees meeting. Another point that needs to be discussed is that transparency requires explanation just after the committees meeting and not after a substantial lag, which is the practice in Pakistan. For instance the explanation of policy change (stated above) was published six months after the policy decisions. Though still desirable, it is far from achieving the objectives of transparency. In conclusion, the SBP is partially transparent in this respect and on the basis of the above discussion, SBP is awarded half score (shown in Figure 3) as it does not explain all decisions after every policy committees meeting and provides explanation only after a substantial time lag.

Policy Inclination: SBP does some forward-looking analysis in its quarterly reports as well as in six- monthly monetary policy statements (MPS). The information in these reports provides some indication about the future stance of the monetary policy. However, a somewhat deeper analysis is required to assess whether or not the SBP is transparent on this issue. There are three points that need to be discussed in this regard. First, the SBP does not publish projection of the future policy rate. Second, from most of the SBP reports, the message on future policy actions is not very clear. Occasionally in its reports, the SBP signals policy tightening while at the same time indicating possible actions for the output growth and vice versa. Third, although the SBP reports do contain some forward looking analysis but it is not done after every policy meeting, which is an essential requirement of transparency on this issue. On the basis of this analysis we can say that SBP does not clearly indicate future policy instrument path and hence is not transparent in this respect (zero score) as indicated in Figure 3.
Operational Transparency

Operational transparency is concerned with the role of monetary policy in achieving targets set by the government. Not all of the variables are in perfect control of monetary authority so there are chances of deviations from the targets. There are essentially three elements in this type of transparency: deviation from operational target (control errors), contribution of monetary policy in achieving final objectives, and unanticipated disturbances that may affect the transmission mechanism. Control Errors: State Bank of Pakistan, in all its reports, regularly announces target for monetary aggregate (M2) and also discusses past deviations and reasons for these deviations. Even in its quarterly reports, it carries out some forecast analysis to assess the likelihood of getting monetary aggregate on target. Though the SBP publishes deviations from the targeted monetary growth, it does not provide this kind of information on operating targets. However, we think that by this practice transparency is not affected because of the following two reasons. First, factors that make monetary aggregate deviate from the target are almost the same that cause deviation in operational target. Second, the question on this issue does not require a time frequency that is greater than one year. So although operational target is needed to be announced and explained more frequently, the question of why the target was missed can be analyzed at annual frequency. According to the options given in Eijffinger and Geraats (2007) question 5(a), SBP is transparent, getting full score on giving explanation for missing the target as shown in Figure 4. Transmission Disturbances: The State Bank of Pakistan provides information on the shocks only superficially without a deeper analysis. In particular, the SBP explains deviations from the target (for inflation and output) but not the forecast errors. However, as targets for one year are just the projections, explaining the deviations from the target implicitly provides information on forecast errors. In this sense, the SBP explains past forecast errors in its documents, e.g. Monetary

Policy Statement of Jul-Dec 2006, gives some idea of explanation by SBP on why inflation target (projection) for the fiscal year 2005 was missed. However, as information provided is only indirect, the SBP is awarded half score on this issue as shown in Figure 4. Policy Evaluation: Although the State Bank of Pakistan does not provide information on the exact contribution of monetary policy in achieving the objectives, it conducts some superficial analysis of policy evaluation. However one can infer from the analyses in the reports that whether or not the policy is successful in achieving stated objectives. There are certain statements in SBP reports showing the relationship between macroeconomic outcomes and monetary policy stance, though the exact contribution of monetary policy in achieving the targets is never mentioned. For instance, in Monetary Policy Statements of the last year, the SBP attempted to communicate that monetary tightening by the bank had contributed to lower inflation. So we have concluded from the statements in SBP reports that monetary policy in Pakistan is partially transparent on policy evaluation according to Eijffinger and Geraats (2007) definition and options in the questionnaire. As Figure 4 shows, SBP has been awarded half score on policy evaluation.

In summary, the SBP has been awarded an aggregate score of 4.5 out of 15. This is lower than any of the central banks score in Eijffinger and Geraats (2007). The most deficient area is the procedural transparency where SBP has scored zero because neither the monetary policy strategy is explicit nor is there a tradition of releasing voting records and minutes of the monetary policy committees meetings. Another area where deficiency is prominent is the policy transparency, where the major deficiency is in the announcement and the clarity of policy operational target and in indicating future policy actions. In political and economic matters there is partial transparency and the major deficiency is in publishing medium term forecasts and in making policy model explicit.

Operational transparency is the only area where there is a moderate level of transparency. Here the performance is better mainly because of providing information on control errors, though there is also partial transparency on transmission disturbances and policy evaluation. It is worth stating that 2 out of 4.5 (total score on transparency in Pakistan) is contributed by operational transparency. Figure 5 shows aggregate score of the SBP.

3.5 Transparency of SBP In Comparison With the Other Central Banks It is instructive to compare the transparency index for State Bank of Pakistan with central banks studied in Eijffinger and Geraats (2007). The comparison mainly focuses on the practices of only those central banks that either got maximum score in an area or their score is very close to that of SBP. Overall, SBP has scored 4.5 (out of 15) and lies at the bottom in comparison with these nine central banks. In Eijffinger and Geraats (2007), the maximum score (14 out of 15) is awarded to the Reserve Bank of New Zealand and Riks bank while the Swiss National Bank got only 7.5 score, the lowest in their sample. The main deficiency of SBP is in procedural transparency where it achieved zero score. Bank of England, Riks bank and Reserve Bank of New Zealand are fully transparent in this regard but most of the central banks are less transparent on this issue, e.g. Swiss National Bank, Reserve Bank of Australia, Bank of Canada and European Central Bank (ECB) got only 1 (out of 3) score on procedural transparency. These central banks are less transparent due to almost the same reason: opacity in providing minutes and voting records of monetary policy committees meetings.

Another area where deficiency of the SBP is more prominent is policy transparency (0.5 score out of 3). Central banks with full score on policy transparency are Federal Reserve, Riks bank and Reserve Bank of New Zealand. The main reason for SBP being at the bottom is opacity in the announcement of operational target. It is interesting to note that none of the central banks in Eijffinger and Geraats (2007) is opaque on this issue. Reserve Bank of Australia, Bank of England and Bank of Japan are least transparent in policy matters as they scored only 1.5 (out of 3). The reason for their deficiency is opacity on policy inclination. Most of the central banks in Eijffinger and Geraats (2007) got full score on political transparency. Interestingly, SBP and Federal Reserve are equally transparent (scoring 1 out of 3) in this respect. Not only this, their reason for deficiency is also the same: both are opaque on quantification of the targets. Bank of Japan that has also low score (1.5 out of 3) has similar reason for deficiency. SBP got the same score (1 out of 3) on economic transparency. Only two central banks, Bank of England and Reserve Bank of New Zealand are fully transparent on this front. On the lower side is the Swiss National Bank with score 1.5. Reason for lower score-opacity regarding policy modelis same for SBP and Swiss National Bank. The only area where SBP has shown significant improvement is operational transparency. Interestingly Reserve Bank of New Zealand (the most transparent central bank on average) and SBP has the same score, i.e. 2 out of 3 on operational transparency. This is the only area where four of the central banks in Eijffinger and Geraats (2007) got score less than that of SBP. Reserve Bank of New Zealand, ECB and Bank of Canada got the same score as SBP did and the reasons for getting this score are common among all these three central banks and the SBP. Federal Reserve, Swiss National Bank, Bank of Japan and Reserve Bank of Australia got score less than that of SBP. A summary of all these results is given in Figure 6 whereas the detailed results are given in Table 1 in the appendix. It is interesting to compare central banks transparency level based on some basic statistics calculated in this study with

Eijffinger and Geraats (2007). The average index value for all the central banks (including SBP) is 10 with a standard deviation of 3. All of the central banks lie within two standard deviations from the average. As the sample size is too small, a more meaningful comparison is on the basis of one standard deviation. According to this criterion only the SBP lies outside the limit from the lower side, whereas two central banks, Reserve Bank of New Zealand and Riks bank, lie outside the limit from the upper side. These results suggest that these two banks are the most transparent while the SBP is the least transparent. So these three central banks are significantly different (in statistical sense) from other banks. Results are given in Figure 7.

4. GLOBAL FINANCIAL CRISIS

4.1 Global Financial Crises in Asia; PAKISTAN: 1. Deepening financial globalization, driven mainly by far-reaching financial market liberalization and openness and benign global economic environment, has helped nations accumulate capital surpluses and augment cross border flows. Exploiting excess liquidity, financial institutions over-leveraged themselves through esoteric and innovative structured products and loan markets (both onand off-balance sheets). In an environment of enhanced risk appetite and high returns, households, corporate and other industry participants invested in these products. Growing defaults and lack of liquidity to back these securities, however, generated an unprecedented credit crunch. In the process of unwinding and settling their obligations, several global banks, investment houses and other entities faced substantial financial losses. Resultant loss of confidence of investors created additional risks to financial stability. 2. The risk appetite for these products consequently turned into risk aversion. Facing losses in asset backed securities and persistent dollar depreciation, investors opted to hedge themselves by investing in global commodities. While advanced countries were dealing with the losses emanating from securitized products, growing investor demand for global commodities resulted in an exceptional hike in international prices of strategic food, oil, metals and other products. 3. The world is not unaccustomed to episodes of crisis and has developed experience and expertise to deal with these events. What is unusual in this round is that the global economy is faced with multidimensional crises: (i) liquidity crunch in inter-bank and money markets, of an unprecedented nature, in the otherwise most lubricated and well nurtured markets; (ii) downturn and distress in housing markets; and (iii) bizarre trends in global commodities markets. Added to this is the unfolding food crisis. The vibrations and gyrations of a crisis that emerged in one small segment of the financial sector in the US were deeply felt across other segments around the globe. These events are a fresh reminder of the costs associated with financial globalization, particularly when there are gaps in the oversight of markets and risk management guidelines are compromised and violated. 4. Given that the epicenters of this wave of global financial crisis are the developed financial markets, the firefighting by the US and a European central banker is helping contain the contagion. Fed and ECBs vigilance on markets, reliance on conventional tools, such as lowering of policy rates, and use of unconventional tools ranging from 2 special liquidity facilities offered on the basis of low grade assets as collateral to rescue operations for housing and investment banks (traditionally not in the purview of central banks) are some examples of how these institutions dealt with the crisis. These central bankers are striking a balance between monetary /stability and financial stability, while walking a tight rope of weighing the tradeoffs between economic growth and

inflation risks. Steepest reduction in the Fed funds rate reflects that the US weighs economic growth risks more serious to its fundamentals and to the global economy while ECB and BOE weigh inflation risks more seriously. Irrespective of this positioning, all three have acted forcefully to stabilize financial markets by easing liquidity in the inter-bank and money markets. If the global economy accelerates by early 2009 as anticipated, all monetary authorities will generally shift their focus back to containing inflation. 5. In my remarks, I will confine myself to the impact of the recent global developments on Asia and the implications for central banks and their policy responses. In offering these perspectives, few qualifiers are in order: The spillover impact of disruptions in developed markets historically has had a limited impact on Asia. As the region grew faster than the rest of the world, the economies expanded and inter-linkages deepened, with the channels of transmission maturing rapidly. Asias resilience was proven after the 1997 Asian financial crisis, as the region was quick to rebound and regain macroeconomic stability. Despite its growing exposures and linkages with world economy, Asias strong export base and oil revenues have helped the region to build external current account surpluses; consequently Asias foreign exchange reserves, which rose to $3.9 trillion (and constitute 62% of the world reserves) now act as a strong buffer. Smaller economies of Asia, however, have limited ability to withstand shocks and their macroeconomic stability has been disrupted and their reserves level has declined in the face of exogenous shocks. Unlike past episodes of crisis, the global economy today faces multidimensional challenges. Interdependence among economies introduces its own complications. Finally, what is worrisome is that neither the financial markets turmoil is over nor the US economic slowdown has bottomed out. Equally uncertain is the outlook for the oil and food prices. Unfolding events in these areas could deepen the impact of developments on Asia. 6. Economic Growth Outlook. In the wake of growing economic diversity and divergence of Asia, it is no surprise that the impact of global developments varies considerably across the region. Interestingly, Asia performed fairly well in the last two quarters of 2007 when, in the first round, the US slowdown was confined primarily to the housing sector. As the liquidity crunch deepened, defaults grew and financial losses magnified, resulting in a fall in US consumer spending and confidence. These and 3 associated developments started to filter down across Asia and are now visibly impacting key economic indicators of the region. While the growth outlook for Asia has softened, the growth prospects remain sound and the overall base line of Asia is strong.

7. Despite multiple forecasts, there is a broad consensus that Asias economic growth is likely to slow down: IMF-Regional Economic Outlook (REO) forecasts that Asias growth in 2008 will be 6.2% -- or about 1 percentage points lower than 2007. Growth of China, with its growing global linkages, is anticipated to be 2.2% lower than the 2007 outcome, India about 1% and the rest of Asia 0.5%. World Bank-East Asia Pacific Updates, 2008 forecasts that developing East Asia growth will falter by 1.5% to 8.5% relative to 2007 but that expected growth is in line with the trends prevailing in the past. Large deceleration in the growth of China in 2008 impacts the average for East Asia. Asian Development Bank- Asian Development Outlook, 2008 forecasts that its member developing countries will grow by 7.6% or almost one percentage point lower than last year. Fund managers and other private entities revised their forecast for different countries by 0.5% to 1.5%. 8. The 2008 outlook for Asia would depend on how uncertainty regarding the US and European economic scenarios resolves itself. While growth outlook has already been moderated, economic activity in Asia will be strong as domestic demand remains robust and is being backed by investment growth particularly in China, India, and ASEAN 5. 9. Trade Prospects. After faltering somewhat, Asias exports have regained momentum; in the recent quarter they grew by double digits. Decline in the US and European markets demand hit Asia hardest in few sectors including IT, electronic, electrical and office machinery industry. Asias exports performance was nonetheless better than the experience of the 2001 recession, as commodity and non-traditional exports, and exports to newer markets continued to grow. 10. Growing trade integration within the region has also served Asia well. While Asias exports to countries outside the region have swelled to $1.7 trillion by 2006, (relative to $0.4 billion in the 1990s) intra regional trade grew faster from under $0.2 billion to $1.6 trillion. Consequently, intra regional trade constitutes almost half of the total trade in Asia, and is set to grow further as Asia is gearing itself for greater market diversification. Impetus to this will come as Japan continues to recover, China deepens its trade with Latin America and other regions, and India opens up further on the back of growing middle class incomes and demand. The regional integration is also evident from the growing momentum and scale of regional free trade agreements. 11. Larger economies of Asia and the ASEAN 5 have a dual cushion of continued large, if not growing, external current account surpluses and exceptionally high foreign exchange reserves. However, few economies face growing macroeconomic vulnerabilities. Largely reliant on import of oil and, now,

food, external current account deficits in these countries have reached unsustainable levels. Macroeconomic instability and developments in the international environment have also impacted foreign inflows to these countries. In this scenario financing external current account deficits is a challenge complicated further by the exceptional rise in sovereign spreads in international markets as the liquidity constraints deepened. 12. Implications for financial markets. Benefiting from the recapitalization, restructuring and stronger regulatory and supervisory systems in the post financial-crisis period, Asian financial markets have been performing well. Emerging Asias financial assets, as percent of their GDP, rose to 306.3, higher than the ratios for Latin American, African or European countries (155.1, 168.7 and 139.0, respectively), but lower than the world ratio of 401.5. 13. Relative to trade, Asias financial markets are less integrated particularly within the region. Emerging Asia (excluding Japan) holds only 10 percent of the worlds total value of bonds, equities and bank assets. Growth and diversification of capital flows to Asia is impressive. Foreign direct and portfolio flows to Asia have reached almost $989 billion or 2% of the world flows and 9.3% of Asian GDP. Three-fourths of the portfolio flows to Asia were directed to equity markets. 14. In contrast, Asian investors have less than 20% of their equity portfolios (in most cases less than 10%) in markets outside the region and are less dependent on overseas bank lending. Notwithstanding, stock market correlations, comovements of interest rates and bond yields, and foreign participation in selected markets, do reflect that Asias financial markets are gradually, but not completely, undergoing global integration. 15. In general, Asias (excluding Japans) exposure to the sub-prime mortgage market was limited and confined to few banks in relatively more developed financial markets. The related losses were estimated to be in the range of $20-30 billion and in most cases these losses have been accounted for. Asian central banks exposure to US mortgage-based securities was also limited, except for China, where these holdings were backed by Government mortgage entities. 16. Financial stress resulted in delays in certain financial deals with Asia but had otherwise little impact on the regions banks and financial institutions. Steeper impact has been observed on securities markets, and to a lesser extent on bond markets, driven by revaluation of risks in financial markets and worries about the global economic outlook. In some cases this resulted mainly in correction of valuation/returns on securities. While the equity markets recovered towards the end of 2007 - with several indices hitting new highs in October they cam under pressure in the beginning of 2008 as myths regarding Asias decoupling from the US and Europe faded. By mid- March 2008, most Asian equity indices were down 1525 percent for the year. Despite the dampening effects on the Asian equity markets, they largely outperformed the mature markets and the world average indices.

17. International debt markets did not go unscathed. Reflecting the liquidity constraints and higher risk premiums, spreads for offshore borrowing widened significantly for both sovereign and other borrowers. Spreads rose for Asia in line with the trends in emerging markets and virtually doubled and tripled (but were below US high yield debt markets). Risk premiums magnified further for countries facing complex economic and political environments. The iTraxx Asia ex-Japan Credit Default Swap (CDS) Index (including sovereign, corporate and financial issuers) surged by almost 300 bps over the last nine months. 18. Inflationary Pressures. Most worrisome have been the inflationary pressures facing Asia. Rise in oil prices towards the end of 2007 and its subsequent surge in 2008 reaching $120 per barrel, and the food supply shortages in economies that had approached self sufficiency, are two major problems. Oil importing economies are now facing high external current accounts deficits whose stress has resulted in currency depreciation. In other economies, rise in US dollar price of oil has been offset by an appreciation of exchange rates. 19. Inflationary pressures and expectation are on the rise as: (i) Governments allow full or partial pass-through to food and oil prices, (ii) core inflation rises due to fiscal pressures magnified by subsidies on food, agriculture inputs and oil products, and budgetary recourse to central bank borrowings, and (iii) investors seek safe havens in the commodities exchange markets. The depreciating dollar can also be given its share of blame for the record high price of oil, almost double its price just one year ago (from $63/barrel to $119/barrel). Given the fast pace of economic activity, it has not taken long for price changes in metals, commodities, and oil to manifest themselves in higher labor costs and increased prices of many finished goods and services. 20. Financial turmoil, its fallout and contagion, is by no means the only reason for the global commodity price pressures. It has to be recognized that the current trend in global commodity prices is not a one-off distortion or a cyclical spike. The global commodity price up trend reflects growing population stress and is likely to now stabilize at a new and higher level. Food prices hike is driven by multiple factors, key among which are: (i) rising population and consumption demand including the China and India factor, (ii) low and stagnating yields, and (iii) farmers switching to crop production for bio-fuels. Larger debate and financing support to resolve the food crisis is likely to rejuvenate food production, albeit with a lag. 21. Policy Responses of Central Banks. As highlighted above, the first round effects of the financial market turmoil were largely contained in Asia, given their limited direct exposure to the sub-prime mortgage and other asset based securities. With grimmer economic outlook and concerns regarding financial stability, both at the home front and globally, Fed, BoE and ECB are taking steps to ease monetary policy through liquidity support and lowering interest rates to

avert recessionary tendencies from permeating deeper. Asian countries face a different set of challenges, though, like developed countries, they have the difficult task of striking an adequate balance between growth and inflation risks. 22. Since economic growth was steadier in 2007, more immediate preoccupation of Asias central bankers since July 2007 has been to deal with growing inflationary pressures. Inflation rates in Asia rose beyond projections and in case of inflation targeting regimes resulted in clear breaches. China and India, the two large economies, have resorted to monetary tightening, but primarily through raising cash reserve requirements by 700 bps and 350 bps since July 2007 , respectively. These attempts to curb liquidity in the system and excessive demand pressures have not arrested the structural rise in prices. Pakistan has been in a monetary tightening mode since April 2005 and has cumulatively raised the policy rate by 350 bps with the last two rounds of increase of 100 bps taking place after July 2007. Meanwhile, other countries have held the policy rates steady. In only few cases, such as Thailand and the Philippines, growth risks outweighed inflation risk. Consequently, policy rates were moderately lowered to ease monetary policy but with inflation creeping high, scope for loose monetary policy may no longer exist. 23. The complexity for central bankers in Asia is that food inflation, with 40-50% weightage in price indices is a major driver of inflationary pressures. An excessive monetary tightening in this situation would end up creating complications for the economy without the desired impact on food inflation that is principally propelled by supply side constraints. At the same time, if monetary policy ignores stubbornly high food inflation, second round impacts would eventually strengthen the inflationary expectations. To resolve this dilemma, Governments are resorting to fiscal subsidies to avoid full pass-through. High fiscal deficit countries cannot afford these subsidies and as such have resorted to a gradual and phased pass-through of rise in prices to consumers. 24. Exchange rate appreciation emerging in a number of Asian economies may offset some of the inflationary pressures. However this option is not available to some countries either because currencies are pegged or external current account deficits are high. Given these limitations, it is best for countries to focus on fiscal consolidation to allow fiscal space for subsidies. However, this should be perceived as a short-term policy response, while encouraging appropriate investments in the agriculture sector to raise productivity and improve functioning of the wholesale and retail markets under vigilance of local authorities, being more non-inflationary ways of dealing with the current chaos in commodity markets. 25. The financial market turmoil and its consequences offer Asian central bankers a number of lessons. Financial globalization with all its benefits does carry significant risks, which hit the weak and under-regulated financial systems more adversely than others. Liquidity crunch and an economic downturn may

lead to losses on a wider range of securities, including some of the more highly rated securities that Asian financial institutions hold in much larger amounts. Moreover, global banks might withdraw financing to Asian economies because of liquidity problems faced in their home markets, which might adversely affect credit conditions. 26. The present events are a reminder that the effects of contagion from small segments of financial markets (i.e. the sub-prime paper and its structured products which are a small proportion of financial assets) or small financial institutions cannot be underestimated as they can threaten and destabilize financial systems and given the cross border exposures can create unexpected turbulence for global financial markets and economy. 27. This dispels any notions of a decoupling from the US economy. The size and scale of interaction between Asia and the US brings immeasurable benefits when the going is good, but it will also bring a measure of misery when the economy is in trouble. Asian central banks and governments need to better integrate with each other to mitigate and hedge such risks in future, take advantage of higher returns, and participate in developments in their own region. 28. Increased appetite for, and under-pricing of risk, needs to be checked so that Asia does not repeat the US mistakes. Asian financial markets and regulators have to be wary of speculators and traders that will invariably be promoting a range of high-risk financial products. Supervisory bodies must fully understand and meticulously examine the extremely technical financial products that they regulate. 29. Liquidity operations and excessive lowering of policy rates, while easing short term constraints, inducing financial stability, and reviving US and other economies, do however pose the attendant risk of inducing global inflationary pressures. The associated bail out of investors presents a moral hazard. Besides promoting once again the issuance of alternative investment vehicles without proper due diligence, floatation of these products and injection of liquidity carries the potential risk of recreating economic bubbles in stock and real estate markets. 30. Asian central banks must realign the institutional framework to face these repercussions while addressing the challenges of the highly intertwined, multidimensional crisis on economic growth. 31. In conclusion, let me reiterate that there is now a broad consensus that slowdown of the US and Europe is likely to have a more distinct impact on Asia. Impact has been slow to filter down to Asia in 2007, but is predicted to impact economic growth in 2008. The initial set-back to exports in the categories of IT, electrical and electronic products has been offset by growth in nontraditional

exports and diversification of trade to newer markets, so much so that Asian exports grew by double digits in a number of countries. 32. Losses on account of sub-prime mortgage markets were limited on the balance sheets of banks and financial institutions and have been written off. In the financial sector, the steepest decline was registered in the securities markets that were fast to recover with the Fed and ECB policy stance, however, the markets remained volatile with corrections in valuations already factored in. 33. Intertwined with financial market turmoil is risk aversion to financially innovative products, and investors move to global commodities whose demand pressures broke all historical price behavior patterns and reached new levels. This price spiral of strategic commodities such as oil, wheat and other products has created dilemmas as pass-through mechanisms are augmenting inflationary pressures, while not passing through this is complicating macroeconomic management. 34. Asias inherent strength and resilience remains intact, supported by all time high reserves being fed by surpluses in external current account and boosted regularly by robust export growth, which in the case of net oil exporting countries has received additional impetus from oil export revenues. This has allowed the region to withstand economic shocks but appropriate policy responses are critical to contain the impact of these shocks. 35. Asias central banks faced additional but different challenges than their counterparts in the West: headline inflation in China has increased to over 8% and in few others countries it has hit double digits. To the extent this is driven by up trend in international oil and food prices with the latter being more a supply side phenomena, central banks in Asia have held on to their monetary policy stance. Asia in any case has been undergoing monetary tightening since 2007 (or a little earlier) and in some cases demand pressures have led monetary tightening via adjustments in reserve ratios while holding policy rates. Greater vigilance remains essential in order to ensure that hike in commodity prices does not set off second round inflationary expectations leading to rising core inflation which in some cases is already rising because of domestic overheating or overborrowings by the Government. To the extent inflation rate is being contained through fiscal measures, this in turn will also impact monetary trends and require further tightening. Abstracting from the larger debate of emerging complications for Asia, I propose to now concentrate on Pakistan. But before I dwell upon the domestic market, it is important to offer a qualifier that in the present environment there is a strong risk that analysis gets detracted by the global financial crisis and its diagnosis, and there is a tendency to draw parallelism between those developments and events and what has been happening in smaller developing countries. There is need for

extreme caution and prudence in ones analysis to ensure that we offer correct diagnosis of the highly impacted countries. What is happening in advanced countries is a financial market turmoil, which manifested itself into a liquidity crisis that has now turned into an insolvency problem. The options and solutions being adopted are highly controversial, and unless accompanied by appropriate actions, could carry moral hazard and loss of taxpayers money. In the context of Pakistan, the diagnosis is different. So rather than facing a financial crisis, Pakistan is caught in a complex macroeconomic problem as twin deficits rose to unprecedented proportion in fiscal year 2007/2008 which remained unattended for some period. Being an open and highly import dependent economy, Pakistan has been hit aggressively by the surge in global commodity prices whose impact magnified as the oil and other strategic import prices rose. As a result, the origins of economic ailments lie in the sharp growth in the domestic fiscal deficit and the external current deficit. Among others, a principal factor for growth in macro-economic imbalance is the continuous rise in import oil prices. On domestic account, subsidies on oil rose to Rs175 billion and on external account side oil import bill was equivalent to 6.9% of GDP or almost 80% of external current account deficit, as the price per barrel of oil touched its heights. During FY08, average price per barrel was $94.4 and the pressure intensified in Q1 of FY09 with average price barrel reaching close to $115.5. Another complexity was with local produce being short of requirements as well as distributional problems, both of which required the Government to import food items which were not anticipated at the start of the year. Concurrent with high global commodity prices, both public and private sector imports in value terms were much higher. Imports cumulatively in FY08 reached $40 billion -- reflecting a growth of 30.9%. Burden of fiscal expansion was clearly unsustainable. The level of stress of the macroeconomic burden can be judged by the growing recourse of the budget on central bank financing, visible in decline in foreign exchange reserves and the depreciation in the currency. Imported inflationary trends and persistent growth in inflationary financing, food inflation as well as pass through of oil, utility and exchange rate adjustments all have combined and have resulted in high inflation. Unless addressed, this high inflation will hurt the competitiveness of Pakistan economy and has eroded the purchasing power of the poor most. Proactive monetary tightening over FY08 was needed and but for it there may have been more complications. The strengths of financial markets came under test during this chaotic period. The equity markets vibrated the most in line with the regional and international markets trends, but the domestic events also played

their role. The banking system performed reasonably well despite the growing public and private sector demands for credit, but sentiments, rumormongering and speculations regarding banks did trigger temporary liquidity constraints. Central banks timely intervention has continued to lubricate the financial markets. In the first round between 11 October to almost 20 October 2008, the central bank released close to Rs250 billion and on 1 November we have additionally released close to Rs 30 billion. The stress on liquidity of course stems from the high public sector borrowings (both Government and parastatals) from the banking system, withdrawal of Government deposits, seasonal eid cash withdrawals from the banks, and the low growth in deposits with few weeks of panic deposit withdrawals. Steadily public confidence is being restored and banks are regaining lost deposits. The banking system has managed to thus far meet the financial requirements of the public sector, while also catering for the stock market as well as the non-bank finance sector. However, a deeper analysis of financial stability, which is underway, has once again brought to the forefront the need for a more balanced growth of the various components of the financial sector. The efficiency of scale that emerges with the availability of long-term and alternative financing options from capital markets, has been conspicuous by its absence. The continued integration and deepening of financial markets is a significant issue for policy makers, and particularly for central banks that are entrusted with the formulation and implementation of monetary policy, since smoothly functioning and efficient financial markets are crucial in ensuring a smooth transmission of monetary impulses. The financial sector is too bank-centric, and the outreach and growth of the Non-Bank Finance Companies and the Insurance sector have languished in recent years. NBFCs face direct competition from banks and are not likely to grow significantly until their funding sources and costs are streamlined. At the same time, growth in the insurance sector is weak, and private pension funds have only recently started to gather some pace. The insurance sector is unlikely to grow unless it gets an infusion of innovation and efficiency. This may require privatization and possible breakup of the dominant state-owned company. The interest from banks to associate themselves with insurance companies and develop new products for cross selling may also revitalize the sector. Private pension funds have an enormous potential as indicated by the growth of such funds in other emerging markets, where they have become important and in some cases, principal institutional investors and the main providers of longterm funds.

To build on the pace and momentum of financial sector reforms, SBP launched the next 10 years financial sector vision and strategy in July 2008. This strategy has been developed based on a comprehensive assessment and evaluation of the banking and the broader financial system that has helped identify the key issues and limitations. In order for the financial sector to develop and reach its potential, broad-based growth will be required, not only of the banking sector but also of other financial institutions and markets. Despite spectacular value growth in recent yearsmuch of which has disappeared in 2008--the relative size of the equity market is still well below peer countries and must grow in the future, based on new company listings and issues. The biggest growth potential lies in the private debt securities market, the development of which would be essential for private investment, especially in transportation and energy infrastructure as well as in housing. 4.2 Measures Taken by the State Bank
Measures Taken to Stabilize Exchange Rate

SBP has taken following measures to stabilize the exchange markets since end April 2008: Exchange companies have been required to surrender a minimum of 15 percent, instead of earlier 10 percent, of foreign currencies received by them from home remittances to the inter-bank markets. (Circular Date: April 29, 2008). Limits on advance payments that were relaxed last year have been tightened. Now advance import payments will only be allowed against letter of credits and that too only to the extent of 50 percent. Advance payments against contracts are now not allowed. Last year advance payments against letter of credit and firm registered contracts were allowed to importers via banks to the extent of 100 percent (Circular Date: April 29, 2008). Exchange companies have been directed to transfer foreign currency from their nostro accounts held outside Pakistan to commercial banks in Pakistan and henceforth exchange companies will have to close all nostro accounts abroad (Circular Date: May 9, 2008). Exchange companies have been encouraged to focus on promoting home remittances and companies can only effect outward remittances to the extent of 75 percent of the home remittances mobilized by the respective company (Circular Date: May 9, 2008). In order to meet the demand of foreign currencies within Pakistan, the Exchange Companies have been directed to surrender their surplus foreign currency to State Bank earlier exchange companies were

exporting most of the foreign currency, except dollars abroad. Now exchange companies, besides dollar, will not be able to export Pound Sterling, Euro and UAE Durhams (Circular Date: May 9, 2008). On July 8, 2008 SBP took the following measures with immediate impact: 1) Forward booking against all types of imports have been suspended temporarily 2) Advance payments against import Letter of credit has been further reduced from 50 percent to 25 percent, 3) All foreign exchange for oil payments will now be made available from State Bank of Pakistan 4) Foreign exchange dealing time for customer and interbank transactions has been restricted, 5) In order to further strengthen monitoring mechanism of transactions made through Exchange Companies, all Exchange Companies will be required to take prior approval of State Bank for all transactions of US$ 50,000 or above on account of outward remittances or sale of foreign currencies to the customers.

Measures Taken to Improve Liquidity and Restore Stability in the Money Market

Besides injection through OMOs and increase in banks effective access to discount window, SBP took a series of steps to ease the liquidity situation and restore stability in the market. These are given as follows: During 11th October to 1st November 2008, SBP reduced the Cash Reserve Requirement (CRR) by 400 bps to 5 percent of the time and demand liabilities (TDL) in a phased manner: a reduction of 100 bps effective from 11th October; a 200 bps effective from 18th October and; another 100 bps effective from 1st November 2008. Effective from 18th October 2008, SBP exempted the time deposits of one year and higher tenor from Statutory Liquidity requirements (SLR); however, SLR ratio for commercial banks and Islamic banks remained unchanged at 19 and 9 percent respectively. Effective from 18th October 2008, SBP allowed securities categorized as Held-to-Maturity for borrowing from SBP under SBPs 3-day repo facility/OMOs. Effective from 18th October 2008, SBP increased the SLR eligibility limit of the PIBs and TFCs from 5 percent to 10 percent of the TDL. Earlier, effective from 27th August 2008, SBP had notified TFCs of various electricity distribution companies as approved securities for the purpose of SLR. On 18th October 2008, SBP decided that advances to deposits ratio (ADR) of any bank shall not exceed 70 percent at any time to ensure prudent liquidity management by banks, where advances were defined as all types of loans less refinance availed from SBP under EFS and deposits were defined as all

types of demand, savings and time deposits less deposits/placements with other banks. Later, on 26th October 2008, the advances were redefined as all types of loans less refinance availed under EFS, lending for commodity operations, lending for power generation and distribution, and lending/placements with other banks. On 5th November 2008, SBP decided to provide 100 percent refinancing to banks against amount disbursed under Part-I of EFS, however, banks will continue to provide 30 percent of financing under Part-II from their own sources. The SBP also decided to refinance the already disbursed amount by banks under Part-I of EFS (from their own sources at the ratio of 30 percent) and outstanding as on 31st October 2008.

5. CONCLUSION & RECOMMENDATIONS

5.1 Conclusion In conclusion, Pakistan has an opportunity to draw lessons from past. Among others, a key lesson is need for effective implementation of reform agenda, though there is a case for launching second-generation reforms to strengthen the governance of country and institutions, which matter in implementation, but cannot be achieved without further institutional reforms. Commitment in addressing the issues and focusing on reforms can go a long way in creating an environment that is conducive to productive economic activity, business friendly environment, and social cohesion. This study has assessed the transparency of the State Bank of Pakistan using Eijffinger and Geraats (2007) index. The SBP is found to be least transparent on certain aspects of monetary policy and is far behind the advanced central banks. The potential areas where SBP can improve transparency include: quantification of the long-term targets for primary objectives, making the policy model explicit, publication of minutes and voting records of policy committees meetings, making monetary policy strategy explicit, and prompt announcement of policy decisions on operating targets and indication of possible future actions. However transparency can be improved in other areas as well. Being the central bank of a developing country, the SBP also needs to focus on effective communication along with the release of information. As the public generally

lacks awareness of central bank working and monetary policy, there is a need to educate the people on these issues. This will enhance private sector learning enabling them to make sound economic decisions, foster public debate on monetary policy issues thereby making objectives of the policy in accord with the societys preferences, and help improve the efficiency of the SBP. In line with Nijathaworn (2007), I also recommend the adoption of a sequential approach for achieving transparency. According to this approach central banks should start with data dissemination followed by releasing information on decision-making process. Then they should focus on publishing economic forecasts and finally on providing information on central banks operations. Economic is complicated and technical discipline and it always works in integration. It is necessary to initiate holistic policy to curb high ratios of inflation and not just relying on tight monetary policy. Governments borrowing needs to be rationalized and should be within the limits. A fund is urgently required to be created to reduce the circular debt among oil and gas producing companies and utilities.

5.2 Recommendations 1. Solutions, strategy and structural reforms: future agenda. So what is the solution in this situation? The answer is to conduct counter-cyclical policies to curb demand pressures by dealing with the root cause of deficits; the sustainable and enduring solution is not only how to finance these deficits but more importantly how to introduce structural changes to reduce these deficit in a sustainable manner, while reflecting on approaches to meet the countrys development requirements. 2. To resolve macroeconomic imbalances on a sustainable basis and meet the growing development requirements, there is need to as high priority focus on enhancing national saving rate, which is a basic ingredient to increase the productive capacity (possible only through well sequenced structural reforms) of the economy to match rising demand. Saving rate has now been historically low and a combination of policies including a countrywide campaign through incentives can help encourage savings. This among others requires to maintain high and stable real interest rate, which given the current high inflationary environment is only possible with high nominal interest rates. In turn, a higher production level in the economy will encourage more savings. The challenge in this context is to remain vigilant about controlling consumption through counter cyclical policies. 3. Recognizing the need to bring the twin deficits within sustainable levels and to increase national savings, the new Government will need to strengthen the

Medium-Term Macroeconomic Stabilization Program and front load it, while accelerating the implementation of structural reforms. These steps will be crucial to re-invigorate growth and strengthen economic resilience. Keeping this in perspective, the Governments broader economic strategy for the next few years will need to include: i. Increasing domestic resource mobilization to raise revenue/GDP ratio by at least 5 percentage points of GDP. This is possible given the scope for enlargement of tax base, removal of exemptions and further strengthening of tax administration. The existing tax regime collects almost 68% of taxes from manufacturing and corporate sector, while agriculture and services sectors (aside from banks) are exempt and some segments of the economy are outside the tax net. ii. Restricting large proportion of new resource mobilized for public investment, while prioritizing the recurrent expenditures through a major overhauling of the Government machinery. iii. Restoring the momentum of privatization of state-owned enterprises, which has been one of the most successful in Asia. The Government has sold off cumulatively almost $7 billion of assets over FY2000-FY2008 and there are around 61 state entities in the pipeline. iv. Providing more autonomy to public sector organizations, with effective leadership and management, to improve their operational and financial efficiencies accompanied by a program to strengthen their balance sheets, which should allow them to graduate from budgetary allocations to seeking funding from the market. v. And raising private investment/GDP from 23% to at least 28%, which involves significant tapping of additional resources both from domestic and international financial markets. 4. To address the structural weaknesses that are inhibiting Pakistans long-term growth there is need for: (i) Exploiting agriculture sector, a key driver for economy, to regain food self sufficiency. Conserving agriculture land and dealing with land holding and entitlement issues so that area under cultivation can be expanded, removing infrastructural bottlenecks (such as inconsistent water availability) and promoting right technology as well as research and development, and strengthening wholesale and retail markets will help improve food availability at a time when global food scenario is worrisome. Greater food production will help cater for rising demand both within Pakistan due to the growing population and its prosperity and outside particularly in the Middle Eastern bloc, India and China. Development of a diversified industrial sector is now urgent to cater for both domestic and external demand. Private sector has to be provided the right incentive and environment for promoting the required diversification. For promoting industry, there is need to broaden and deepen private equity and

(ii)

debt markets this will help diversify financial sector too which is exclusively dependent on the banking system that carries its own attendant risks. Closely held companies should be encouraged to move more and more to capital markets and to examine opportunities for mergers and acquisition and to attract foreign investment to achieve scale and efficiencies. (iii) Instead of focusing on ad hoc subsidies that reach largely the profitable industry, it is best to design incentives to focus on ensuring adequate supply of infrastructure. All new funding, be it taxes or proceeds mobilized from the privatization of infrastructure should henceforth be kept in a separate account and this funding should be exclusively dedicated for developing infrastructure in dedicated industrial sites. For modernization of the industry, SBP and the Government is already focusing on provision of right incentives for import of plant and machinery. These measures will help industrial the sectors ability to compete effectively and achieve an organic and natural growth. Scope for exports is significant only if the industry achieves scale, value addition, diversity, and develops information technology and outsourced businesses from the West. (iv) Foreign investment would receive a further impetus if the legal system is overhauled to ensure elimination of cumbersome procedures, effective enforcement of property rights and business contracts and availability of timely justice. 5. To make it more logical and achievable/controllable, budget deficit for FY09 has been rolled back to 4.7 percent of GDP and government has committed itself to achieve net zero borrowing from SBP during the course of the year, while enhancing its reliance on other non-bank sources. 6. Government ought to amend the Fiscal Responsibility and Debt Limitation Act, 2005 to include provisions for recognizing the need to phase out the Governments dependence on SBP borrowings over a period. 7. Fiscal framework for FY09 should be dynamic to incorporate necessary adjustments as economic developments evolve. Early indications are that the budget deficit target for FY09 of 4.7 percent of GDP is already coming under stress. 8. The government should provide subsidy on imported oil and government should plan to explore oil and other natural resources like gas, and coal. 9. Long-term investment and consistent policies require stable political government and stable political government and democracy require a just judicial system. 10. In order to enhance the food production, farm productivity and streamline the supply chain the government should pay attention to agriculture sector by

providing subsidy loans, fertilizers, seeds, pesticides and consultancy services to farmers 11. In order to negate the bad effects of high discount rates more meaningful and effective incentives in terms investment friendly policies like tax holidays, cheap energy and raw material to the industrial sector should be given. 12. The government should adopt the policy of self-reliance and strictly apply simplicity drive. Indirect taxes play a prominent role in boosting prices. Direct taxes contribute only 34% while indirect taxes 66% which is too much. Producer shifts the burden of indirect taxes on consumers by increasing the price of taxed items. So its hold is rationalized. 13. Ours is the energy deficit country. Kalabagh Dam project has been abandoned. Due to shortage and high prices of electricity, the cost of production is high, as a result food and non-food items are expensive. Dams should be constructed and government should adopt cheapest sources of energy. Provision of adequate water to agriculture sector would definitely bring the prices down as commonly practiced in India, New Zeeland and Netherlands. 14. Fiscal deficit, trade deficit and current account deficit are responsible for inflation. The government should take holistic action to remove these deficits. 15. Smuggling, white-money, parallel economy, undocumented economy, blackmarketing, hoarding and profiteering have also been a source of an increase in general prices in the country. It is estimated that annual generation of black money is about 25% of GNP of the country. In the country there is no magistracy system now, which was present since before 2000 due to which price stability mechanism has already been collapsed. 16. Loans to small traders, businessmen, corporate entities and developers will have a positive impact should be treated separately. General plea of the business community and other side of the picture: Majority of the countrys businessmen termed the monetary policy un-friendly for the business and stressed that central bank should adopt alternate measures to arrest rising inflationary trend in the country. Traders believed their business will be jolted by the enhancement of discount rates from 12 to 13 percent and the monetary policy will fail to counter inflation. It has multiplier effects on the domestic industry too. The import of raw materials will become more expensive for local industrialists which ultimately further increase cost of production. It is feared among the businessmen that the countrys leading export sectors will become weaker in the global markets and it would be difficult to achieve the exports target of $22.1 billion for 2008-09. The monetary policy will also dent

countrys exports sector resulting in decline of foreign exchange reserves. Pakistan was on its way to becoming one of the most expensive countries of the world.

BIBLOGRAPHY

APPENDIX - A
QUESTIONNAIRE

The precise formulation of the central bank transparency index by Eijffinger and Geraats (2007) is reproduced with the collaboration of SBP here. There are a total of fifteen questions and all questions carry equal weight; so aggregate score for a particular central bank can vary from zero to fifteen. 1. Political Transparency Political transparency refers to openness about policy objectives. This comprises a formal statement of objectives, including an explicit prioritization in case of multiple goals, a quantification of the primary objective(s), and explicit institutional arrangements. (a) Is there a formal statement of the objective(s) of monetary policy, with an explicit prioritization in case of multiple objectives? No formal objective(s) = 0. Multiple objectives without prioritization = 1/2. One primary objective, or multiple objectives with explicit priority = 1. (b) Is there a quantification of the primary objective(s)? No = 0.

Yes = 1. (c) Are there explicit institutional arrangements or contracts between the monetary authorities and the government? No central bank, contracts or other institutional arrangements = 0. Central bank without explicit instrument independence or contract = 1/2. Central bank with explicit instrument independence or central bank contract (although possibly subject to an explicit override procedure) = 1. 2. Economic Transparency Economic transparency focuses on the economic information that is used for monetary policy. This includes economic data, the model of the economy that the central bank employs to construct forecasts or evaluate the impact of its decisions, and the internal forecasts (model based or judgmental) that the central bank relies on. (a) Is the basic economic data relevant for the conduct of monetary policy publicly available? The focus is on the release of data for following five variables: money supply, inflation, GDP, unemployment rate and capacity utilization. Quarterly time series for at most two out of the five variables = 0. Quarterly time series for three or four out of the five variables = 1/2. Quarterly time series for all five variables = 1. (b) Does the central bank disclose the formal macroeconomic model(s) it uses for policy analysis? No = 0. Yes = 1. (c) Does the central bank regularly publish its own macroeconomic forecasts? No numerical central bank forecasts for inflation and output = 0. Numerical central bank forecasts for inflation and/or output published at less than quarterly frequency = 1/2. Quarterly numerical central bank forecasts for inflation and output for the medium term (one to two years ahead), specifying the assumptions about the policy instrument (conditional or unconditional forecasts) = 1. 3. Procedural Transparency Procedural transparency is about the way monetary policy decisions are taken. It involves an explicit monetary policy rule or strategy that describes the monetary policy framework, an account of policy deliberations and how the policy decision was reached. (a) Does the central bank provide an explicit policy rule or strategy that describes its monetary policy framework? No = 0. Yes = 1.

(b) Does the central bank give a comprehensive account of policy deliberations (or explanations in case of a single central banker) within a reasonable amount of time? No, or only after a substantial lag (more than eight weeks) = 0. Yes, comprehensive minutes (although not necessarily verbatim or attributed) or explanations (in case of a single central banker), including a discussion of backward and forward-looking arguments = 1. (c) Does the central bank disclose how each decision on the level of its main operating instrument or target was reached? No voting records, or only after substantial lag (more than eight weeks) = 0. Non-attributed voting records = 1/2. Individual voting records, or decision by single central banker = 1. 4. Policy Transparency Policy transparency means prompt disclosure of policy decisions. In addition, it includes an explanation of the decision, and an explicit policy inclination or indication of likely future policy actions. (a) Are decisions about adjustments to the main operating instrument or target promptly announced? No, or after a significant lag = 0. Yes, at the latest on the day of implementation = 1. (b) Does the central bank provide an explanation when it announces policy decisions? No = 0. Yes, when policy decisions change, or only superficially = 1/2. Yes, always and including forwarding-looking assessments = 1. (c) Does the central bank disclose an explicit policy inclination after every policy meeting or an explicit indication of likely future policy actions (at least quarterly)? No = 0. Yes = 1. 5. Operational Transparency Operational transparency concerns the implementation of the central banks policy actions. It involves a discussion of control errors in achieving operating targets and (unanticipated) macroeconomic disturbances that affect the transmission of monetary policy. Furthermore, the evaluation of the macroeconomic outcomes of monetary policy in light of its objectives is included here as well. (a) Does the central bank regularly evaluate to what extent its main policy operating targets (if any) have been achieved? No, or not very often (at less than annual frequency) = 0.

Yes, but without providing explanations for significant deviations = 1/2. Yes, accounting for significant deviations from target (if any); or, (nearly) perfect control over main operating instrument/target = 1. (b) Does the central bank regularly provide information on (unanticipated) macroeconomic disturbances that affect the policy transmission process? No, or not very often = 0. Yes, but only through short-term forecasts or analysis of current macroeconomic developments (at least quarterly) = 1/2. Yes, including a discussion of past forecast errors (at least annually) = 1. (c) Does the central bank regularly provide an evaluation of the policy outcome in light of its macroeconomic objectives? No, or not very often (at less than annual frequency) = 0. Yes, but superficially = 1/2. Yes, with an explicit account of the contribution of monetary Policy in meeting the objectives = 1.

APPENDIX - B

Table 1