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STATE BANK OF PAKISTAN

Presented By:
Aasim Ali Moughal Fahad Mazher Ali Sana Zahra Uzma Latif

Presented To:
Sir, Asif Naqvi

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Preface
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When our respected Teacher Sir, Asif Naqvi told us about the term project and topic of our own choice, at that time we decided to go for the most important bank, State Bank of Pakistani had many reasons while selecting this vast and difficult topic. State bank of Pakistan is responsible for the efficient and effective control of whole banking sector in Pakistan. Banking sector in any economy plays a very vital and inevitable role. Overall monitoring of banking sector, control of inflation, foreign exchange and issue of money are the primarily tasks of the state bank of Pakistan. i At the level where we are standing now it was very difficult for us to complete a project on the state bank of Pakistan but with the blessings of Almighty God and the Guideline given by ....................................................... We have put our best efforts in discussing state bank comprehensively. We collected basic data about the state bank mainly from website of state bank, state bank Lahore office. We took also help from a book Money banking and finance. The whole assignment is divided into 4 parts. In first part history of state bank, in 2nd part, we have discussed the core functions and some important departments, in 3rd we have put light to monetary policy and tools of monetary policy and in the last part we have provided details about swot analysis and also highlight some other areas of state bank. Although we have tried to present a correct and clear view of state bank of Pakistan but as it is the most difficult and complex task, so there might be many mistakes. It is very important to us to mention the name of......................., the who co-operated with us in a very lenient way. We shall be obliged if any one inform us about our mistake in this project.

AASIM ALI MOUGHAL FAHAD MAZHER ALI SANA ZAHRA UZMA LATIF

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Dedication
We dedicate this effort to our loving parents Because it is only because of them that we are Enjoying such a status of life.

ACKNOWLEDGEMENT
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COUNTLESS THANKS TO HE WHO IS LORD OF LORDS

At first instant, humbly we bow our head with all the feeling of our heart and soul before the Almighty Allah, the beneficent, the omniscient who bestowed us with all the mental abilities to work out this project. We feel highly honoured to express our profound gratitude to our respected teacher SIR ASIF NAQVI, whos ever encouraging, keen interest and sympathetic behaviour proved to be a light house to complete this project. I would like to express my cordial gratitude to the employees of state bank of Pakistan Lahore office, especially MR We would commit a moral lapse if we do not mention our parents through whose patronage prayers, we happened to come up to this level of qualification

Vision Statement

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GIVE LOAN TO GOVERNMENT AND COMMERCIAL BANKS FOR ACCOMPLISHMENT OF MEGA PROJECTS IN THE COUNTRY.

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Mission Statement

OUR MISSION IS TO PROMOTE SOUNDNESS AND STABILITY OF THE BANKING SYSTEM THROUGH PROACTIVE SUPERVISION AND PROMPT ENFORCEMENT ACT.

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Quaid-i-Azam's Speech On the occasion of the Opening Ceremony of The State Bank of Pakistan on 1st July, 1948.

"Mr. Governor, Directors of State Bank, Ladies and Gentlemen. The opening of the State Bank of Pakistan symbolises the sovereignty of our State in the financial sphere and I am very glad to be here today to perform the opening ceremony. It was not considered feasible to start a Bank of our own simultaneously with the coming into being of Pakistan in August last year. A good deal of preparatory work must precede the inauguration of an institution responsible for such technical and delicate work as note issue and banking. To allow for this preparation, it was provided, under the Pakistan Monetary System and Reserve Bank Order, 1947, that the Reserve Bank of India should continue to be the currency and banking authority of Pakistan till the 30th September, 1948. Later on it was felt that it would be in the best interests of our State if the Reserve Bank of India were relieved of its functions in Pakistan, as early as possible. The State of transfer of these functions to a Pakistan agency was consequently advanced by three months in agreement with the Government of India and the Reserve Bank. It was at the same time decided to establish a Central Bank of Pakistan in preference to any other agency for managing our currency and banking. This decision left very little time for the small band of trained personnel in this field in Pakistan to complete the preliminaries and they have by their untiring effort and hard work completed their task by the due date which is very creditable to them, and I wish to record a note of our appreciation of their labours. As you have observed, Mr. Governor in undivided India banking was kept a close preserve of non-Muslims and their migration from Western Pakistan has caused a good deal of dislocation in the economic life of our young State. In order that the wheels of commerce and industry should run

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smoothly, it is imperative that the vacuum caused by the exodus of non-Muslims should be filled without delay. I am glad to note that schemes for training Pakistan nationals in banking are in hand. I will watch their progress with interest and I am confident that the State Bank will receive the cooperation of all concerned including the banks and Universities in pushing them forward. Banking will provide a new and wide field in which the genius of our young men can find full play. I am sure that they will come forward in large numbers to take advantage of the training facilities which are proposed to be provided. While doing so, they will not only be benefiting themselves but also contributing to the well-being of our State. I need hardly dilate on the important role that the State Bank will have to play in regulating the economic life of our country. The monetary policy of the bank will have a direct bearing on our trade and commerce, both inside Pakistan as well as with the outside world and it is only to be desired that your policy should encourage maximum production and a free flow of trade. The monetary policy pursued during the war years contributed, in no small measure, to our present day economic problems. The abnormal rise in the cost of living has hit the poorer sections of society including those with fixed incomes very hard indeed and is responsible to a great extent for the prevailing unrest in the country. The policy of the Pakistan Government is to stabilise prices at a level that would be fair to the producer, as well as the consumer. I hope your efforts will be directed in the same direction in order to tackle this crucial problem with success. I shall watch with keenness the work of your Research Organization in evolving banking practices compatible with Islamic ideas of social and economic life. The economic system of the West has created almost insoluble problems for humanity and to many of us it appears that only a miracle can save it from disaster that is not facing the world. It has failed to do justice between man and man and to eradicate friction from the international field. On the contrary, it was largely responsible for the two world wars in the last half century. The Western world, in spite of its advantages, of mechanization and industrial efficiency is today in a worse mess than ever before in history. The adoption of Western economic theory and practice will not help us in achieving our goal of creating a happy and contended people. We must work our destiny in our own way and present to the world an economic system based on true Islamic concept of equality of manhood and social justice. We will thereby be fulfilling our mission as Muslims and giving to humanity the message of peace which alone can save it and secure the welfare, happiness and prosperity of mankind. May the Sate Bank of Pakistan prosper and fulfil the high ideals which have been set as its goal. In the end I thank you, Mr. Governor, for the warm welcome given to me by you and your colleagues, and the distinguished guests who have graced this occasion as a mark of their good wishes and the honour your have done me in inviting me to perform this historic opening ceremony of the State Bank which I feel will develop into one of our greatest national institutions and play its part fully throughout the world."

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P EE T RSN GVR O OE N R

Present Governor of State Bank of Pakistan

Yaseen Munawer

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PAST GOVERNORS

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(Late) MR. ZAHID HUSSAIN (10-06-1948 TO 19-07-1953)

(Late) MR. ABDUL QADIR 20-07-1953 TO 19-07-1960)

(Late) MR. S.A. HASNIE (20-07-1960 TO 19-07-1967)

(Late) MR. MAHBUBUR RASCHID (20-07-1967 TO 01-07-1971)

MR. S.U. DURRANI (01-07-1971 TO 22-12-1971)

MR. GHULAM ISHAQ KHAN (22-12-1971 TO 30-11-1975)

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(Late) MR. S. OSMAN ALI (01-12-1975 TO 01-07-1978)

MR. A.G.N. KAZI (15-07-1978 TO 09-07-1986)

MR. V.A. JAFAREY (10-07-1986 TO 16-08-1988)

MR. I.A. HANFI (17-08-1988 TO 02-09-1989)

MR. KASSIM PAREKH (05-09-1989 TO 30-08-1990)

DR. MUHAMMAD YAQUB (25-07-1993 TO 25-11-1999)

Dr. Ishrat Hussain

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STATE BANK OF PAKISTAN

State bank of Pakistan is central bank of our country. This is most important financial institution of Pakistan and is the leader in this field. STATE BANK OF PAKISTAN is not guided by profit motive. It acts only in interest of country.

THE HISTORY OF STATE BANK OF PAKISTAN;

After partition there were many difficulties in banking system of newly born state. Initially, it was decided that reserve bank of INDIA would continue to act as CENTRAL BANK of PAKISTAN, until PAKISTAN establishes its own.

CONSTITUTION AND SETUP;

The reserve bank of INDIA did not perform its functions with diligence and good faith for PAKISTAN. This bank refused to transfer rupees 55 crore which PAKISTAN was entitled to reserve as proportionate share of reserves of undivided IN So, Governor General of PAKISTAN QUAID-EAZAM issued order of the establishment of SBP on 12 MAY, 1948.

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O I E OS P F CS F B F

ITS TOTAL 16 OFFICES ARE HERE;

2 OFFICES ARE IN KARACHI 1-Head Office 2-Branch in Naziabad LAHORE ISLAMABD RAWALPINDI QUETTA MULTAN BAHAWALPURE HYDARABAD GUJRANWALA SAKAR D.I.KHAN PESHAWAR FAISALABAD MUZAFFARABAD

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OBJECTIVES & POWERS

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OBJECTIVES OF STATE BANK OF PAKISTAN;

State bank of Pakistan has two manifold objectives;
Issuance of currency notes Advancement of country towards development and prosperity

POWERS OF STATE BANK OF PAKISTAN;

Powers of STATE BANK OF PAKISTAN to regulate money supply and control of financial institutions in country were increased in 1956, 1974 and 1997. The National Assembly increased the power through its act, STATE BANK OF PAKISTAN act 1956, Banks Nationalization Act 1974, Bank Companies Act 1997.

SHARING CAPITAL
The STATE BANK OF PAKISTAN had share capital of rupees 3 crore divided in to 3 lac fully paid of shares of rupees 100 each of the share of capital, 51% was contributed by central government and remaining 49% was subscribed by the public. However after nationalization in 1974 the federal government took the remaining 49% also after paying compensation to private share holders through endorsement of negotiable loans repayable at per at any time within 15 years.

MANAGEMENT
The management and supervision of bank vests in CENTRAL BOARD OF DIRECTORS. The CENTRAL BOARD OF DIRECTORS consists of, ONE GOVERNOR, TWO DEPUTY GOVERNORS AND EIGHT DIRECTORS The chief executive of bank is governor. He is responsible for controlling the affairs of bank on behalf of central board. The governor is appointed by federal government for a term of maximum duration of 5 years. The central board of directors must have at least 6 meetings in a year. There is an executive committee headed by governor, which controls day-to-day business of bank, on behalf of central board of directors. Its head office is at KARACHI.

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OFFICIAL RANKS OF CENTRAL BOARD OF DIRECTORS;

Governor; 1) 2) 3) 4) 5) 6) Yaseen Munawer

Reporting officers to governors. CHIEF ECONOMIC ADVISOR SR. ADVISOR TO GOVERNMENT HUMAN RESOURSES ADVISOR TO GOVERNOR EXCHANGE AND DEBIT MANAGEMENT ADVISOR ECONOMIC ADVISOR PROJECT MANAGER IT ADVISOR Besides these other important authorities includes;

EXECUTIVE DIRECTORS, FINANCIAL RESORCE MANAGERS, SUPPORTS SARVICES AND HUMAN RESOURCES DIRECTORS, BANKING INSPECTION DEPTT. DIRECTOR AUDIT DEPARTMENT

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CORE FUNCTIONS

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Core functions:
State Bank of Pakistan is the Central Bank of the country. While its constitution, as originally lay down in the State Bank of Pakistan Order 1948, remained basically unchanged until 1st January 1974 when the Bank was nationalised, 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 utilisation 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 Nationalisation 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. 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, 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 islamization of the banking system. The main functions and responsibilities of the State Bank can be broadly categorised as under.

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REGULATION OF LIQUIDITY
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 Co-ordination 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 characterised 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 programme has been developed. In terms of the programme, 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.

REGULATION AND SUPERVISION

Regulation and supervision of the financial system is the primary responsibility of state bank 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 complex 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 endeavouring hard to keep pace with the fast-changing financial landscape of the country. 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).

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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 loam 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.

EXCHANGE RATE MANAGEMENT AND BALANCE OF PAYMENTS

Another very important and major responsibility 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 authorised 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 explosions 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 authorised 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

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investment of surplus funds in such a manner that ensures liquidity of funds as well as maximises 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.

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 utilisation 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 realisation 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-recognised 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 subsidised credit, and development of the capital market.

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FUNCTIONS

The State Bank of Pakistan performs all those functions, which a central bank is supposed to do. Like a Central Bank in any developing country, the State Bank of Pakistan performs both the traditional and development functions to achieve Macro economic goals. The traditional functions may be classified into two groups:

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A)

Primary functions

Including issue of notes .regulations and supervision of financial System, bankers bank, lender of last resort, banker to government and conduct of monetary policy. B)

Secondary functions

Including the agency functions like management of public dept , management of foreign exvhange, etc. and other functions like advising the government on policy matters and maintaining close relationship with international financial institutions.

Note issuing agency

SBP enjoys monopoly in the issue of notes. It issues 10-rupee, 50-rupee, 100-rupee and 1000 rupee notes. The bank follows the proportional reserve system. All notes issued by it are backed by at least 20% in the form of gold Coins.

Banker to the government

The SBP of Pakistan acts as a banker to the central and provincial Govt. Hold cash balances of Govt free of interest Provide short term loans to the Govt. Pays salaries of Govt employees Collects tax revenue and makes payment on the behalf of Govt.

Bankers bank
The SBP is the leader of banking system. Thus Its provides loan to banks through rediscounting of bills It provides guidance and direction to other banks to formulate their policies about deposits, credit, Investment and interest rate It fixes the cash deposit ratio for commercial banks. All the banks send a weekly statement of its assets & liabilities to state bank.

Lender of last resort

It means that whenever the banks are short or funds and are unable to get help from anywhere, it is the central bank, which provides them, loans and brings them out of trouble. Quaid E Azam School of Management Sciences

Clearing house
SBP also performs the functions of a clearing house. Since State Bank holds cash reserves of others bank, it can easily settle their Mutual payments.

Manager of public dept

The State bank manages all debts secured by federal and provincial Govt from local sources as well as foreign countries

Guardian of reserves
The state bank is guardian of all types of monetary reserves. Gold and Foreign exchange reserves or the Govt. are kept with the bank.

Manager of foreign exchange

Whenever some banks run short of cash and are unable to get help from Other sources, the state bank comes to rescue. The State bank lends enough funds to them to ensure their liquidity & solvency.

Controller of credit
The State bank is the guardian and manager of money market in the country. Since the total supply has close relation with economic activity the government has given it vast powers to regulate the volume and direction of bank loans.

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MONETARY POLICY

DEFINATION
Control of total credit in the economy and total money supply is call monetary policy. Credit has assumed great importance in the modern economic system. Thus, For the economic stability of a Quaid E Azam School of Management Sciences

country, a proper control and regulations of Credit money is essential. If the bank issues too much credit money, it lead to inflation. On the other hand tight control over this money may cause Depression and unemployment.

Objectives of credit control.

Following are the objectives of Monetary Policy

1. Full employment
One of the objectives of monetary policy s to create more opportunities of employment in all sectors of economy. It helps in the maximizing utilization of all the resources available in the country.

2. Foreign Value of Currency

Monetary Policy helps in improving the external value of home currency, which leads to growth in trade.

3. Increase in Investments
With the help of monetary policy Central bank tries to increase investments both domestic and foreign, which results in economic stability.

4. Stability in Capital Market

The development of any country depends upon its stable capital market. Monetary policy helps in order to create stability in capital market.

5. Price Stability
Monetary policy helps in creating price stability in the country by controlling inflation and deflation.

6. Control on Inflation and Deflation

Monetary policy creates economic stability in the country by controlling inflation and deflation.

7. Equitable Distribution of Credit

Monetary policy ensures equitable distribution of credit to all the sectors of economy as well as to the backward areas and also to the small borrowers. Quaid E Azam School of Management Sciences

8. Increase in production
With the help of monetary policy various productive sectors are encouraged to get loans due to which there is an increase in production.

9. Exchange Stability
Monetary policy helps creating exchange stability by improving balance of payment position.

10. Promotion of Economic Development

Monetary policy also plays a vital role for the economic development of the country. It aims at mobilization of monetary resources and ensuring their full productive use.

State Bank of Pakistan issues Monetary Policy

The macro-economic outlook and monetary policy stance reads:

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Recent global trends point to an improved economic outlook as the US and other developed economies have exhibited significant recovery and growth that started in the later half of the last fiscal year. The developing nations have benefited from the on-going recovery in the developed world and higher capital inflows, and most of the nations including Pakistan have been able to achieve or even surpass growth targets. Although high demand in the developed world is the driving force behind the global economic up-turn, there are risks of relatively high inflation and long-term slowdown due to higher US deficits caused by heavy tax cuts and costs associated with the war against terrorism. This has led to rising inflationary expectations worldwide and therefore, interest rates are likely to continue to increase in the international financial markets. These developments may have, to some extent, dampening effects on investment and economic growth the world over. Pakistan's economy has experienced broad-based economic growth during FY04. The country is estimated to have achieved a growth rate of 6.4% against the target of 5.3%. Principal factors were the intentional growth-oriented monetary and exchange rate management in a low inflation scenario, improved fiscal discipline, stable political environment and better relations with neighbours. Prevalence of low interest rates on account of easy monetary policy under less inflationary environment fuelled growth helping to accelerate the pace of economic recovery. The low cost funds available to the corporate sector enabled many companies to strengthen their balance sheets, improve profitability and invest retained earnings along with bank borrowing into expansion, modernization or higher capacity utilization. On the external front, though the imports also grew more than expected, export earnings crossed the $12.0 billion mark for the first time mainly due to rising export competitiveness. Workers' remittances amounted to $3.87 billion, higher than estimated for the FY04. However, there was a decline in other net foreign capital inflows. Pakistan's economy is, therefore, better placed in terms of achievement of medium-term growth targets in view of the momentum already gained in the last fiscal year and existing global trends that augur well for the world economy, at least in the short term. GDP growth for FY05 is projected at 6.6% with the manufacturing sector taking the lead to grow by over 10%, agriculture sector expanding at 4% and the services sector to grow at 6.2%. Due to higher increases in prices recently, the inflation is targeted to increase by 5%. To achieve these targets, the broad money expansion is targeted at 11.4% for the FY05, slightly less than the nominal growth rate target. Consistent with higher growth and development, the main thrust of monetary and credit policy would be to ensure adequate availability of bank credit to private sector while containing inflation. The constellation of risks has changed in a perceptible manner since the issuance of last Monetary Policy Statement. On the negative side:

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* International interest rates have begun to edge up and there is a fairly strong expectation that these rates will move upwards in the coming quarters. The differential between Pakistan Rupee interest rates and US Dollar, Euro, Yen and Sterling Pound interest rates should not be allowed to widen. * Strong import demand witnessed in FY04 is unlikely to be depressed in the current fiscal year worsening the trade balance and therefore exerting a downward pressure on the exchange rate. * Domestic private credit demand has peaked in FY04 and therefore the rate of expansion will be moderate but still a large portion of net domestic asset growth will be pre-empted by the private sector. * Hike in asset prices, adjustment in wages and salaries awarded to public servants will also put upward pressure on prices. On the positive side: * Fiscal deficit is likely to remain at 4 percent of GDP and along with the improved financial balances of public sector enterprises the demand from the public sector, barring any unforeseen events, would not pose any serious concern. * Lower capital inflows would moderate the monetary and reserve money growth. * Lower world prices of raw cotton should help the textile and clothing sector in its export drive but much depends on how fast the textile export industry is able to expand its share in the post-MFA textile markets of North America and Europe. * The continued growth of textile sector should take place with lower demand for working capital from banking system thus easing somewhat the pressure on private sector credit. Imports of wheat of one million tones should facilitate the government to stabilize the prices of wheat flour during the lean months effectively but the uncertainty about oil and commodity prices remains worrisome.

The state of labour market shows high degree of unemployment in the country with very low pressure for wage rise outside the public sector. An inappropriate or more aggressive monetary policy will only aggravate the unemployment problem. The balance of risks indicates that domestic prices may continue to increase and exchange rate may be under pressure in the coming six months. The lingering overhang from the last two years' monetary expansion has to be wrung out of the system thus lowering the inflation risk premium built into market expectations.

Therefore, the State Bank will continue to exercise vigilance on the movement of key variables and make a smooth transition from an expansionary monetary policy stance to measured tightening to avert inflationary pressures and maintain stability in exchange rate. This measured response will have to ensure that the current growth and investment momentum in the country is not impaired in any significant manner; export competitiveness is maintained while inflation is kept under control. Raising interest rates rapidly or aggressively when the economic

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recovery is still incipient, a significant slack exists, and unemployment rates are rising, will entail real economic costs.

OF MONETARY INSTRUMENT POLICY

The control of credit is responsibility of the central bank. For this purpose Central bank uses various methods. These are classified into two types.

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a) Quantitative control.
These include Bank Rate Policy Open Market Operations(OMO) Variations in Reserves Requirement Credit Rationing

b) Qualitative control.
These include Change in Margin Requirement Regulations of consumer s credit Moral persuasion Publicity Direct action

Open Market Operations:Sale and purchase of government securities in the open market (stock exchange) by central bank is called open market operations.

FUNCTIONS:

Buying Securities;
State bank can buy securities either from the commercial banks or from public.

Selling securities;
Securities can be sold either to banks or to public their lending power increase. when it sells securities, it hands over securities to commercial banks. Commercial banks pay cash to central bank, this reduces the commercial banks cash reserves and their lending power is reduced. When the securities are purchased by public, then public makes payments by cheques which are drawn on commercial banks. Hence deposits with the commercial bank decreases, the final effect is same again; the cash balance and hence credit creation powers of banks are reduced.

Effect on interest rate;

When securities are purchased by central bank then commercial banks end up with excessive cash reserves. In order to attract borrowers and investors They lower interest rates.

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When securities are sold, this result in reduced cash reserves with commercial banks. If there is high demand for loans from borrowers and investors, the interest rate and hence cost or borrowing rises.

Purpose of Open Market Operations (OMO)

Other functions of Open Market Operations To administer and maintain the prices of government securities To create suitable climate for the floatation of new loans To activate the money market To manage gold inflows and outflows To create climate in which other tools of monetary policy To avoid sudden fluctuations in the money market To support government credit

Limitations or Assumptions;
No doubt OMOs are extremely effective tools of monetary management and control. However, they need a particular climate and conditions to work effectively. Following are the limitations which effect OMOs

Undeveloped Market
For Open Market Operations to be effective the money and capital market must be fully developed. In the absence of broad and developed market the Bank will not be able to sell or buy government securities well in time exert desire influences on the economy. A suitable institutional frame work is required so that a central bank could conduct open market operations.

Excessive Cash Reserves;

The basic rational of open market operations is to decrease cash balances commercial banks so that their lending power is reduced. Now if commercial have such excessive cash reserves, that purchasing securities do not produce reduction in their cash balances then open market operations will be ineffective.

Availability of securities;
For Open Market Operations to be effective there must be ample and adequate securities. The central bank purchases securities at high prices in order to stimulate economy and to push it out of Quaid E Azam School of Management Sciences

depression or slump. The total amount of securities must from some considerable proportion of the total excessive cash reserves.

Economic Climate
The economic climate of the country also determines the effectiveness of Open market Operations. The trends of economic indicators, the overall past perform and, future speculations, price and exchange conditions, all such factors effect the willingness of borrowers and bankers and hence decide the fate of open market operations.

Willingness of Borrowers
The investors and borrowers attitude is an important factor that can disturb the central bank plans based on open market operations. If the borrowers are discouraged and disappointed and they have become pessimist about future then they will not like to borrow or to make investment. In such a case if a central bank tries to expand credit and money supply through open market operations then this will not prove fruitful. Unless the investors confidence is restored, he will not borrow despite excessive cash reserves of commercial banks and low cost of borrowing.

Willingness of bankers
The bankers attitude also plays a role in deciding the fate of open market operations. Commercial banks are profit seeking institutions and they have their own Priorities sometimes they are not willing to expand credit and advance loans despite excessive cash reserves and purchasing of securities by government. On other hand when central bank wants to contract credit and sells securities, commercial banks driven by their own priorities may continue to advance loans. In both these cases open market operations will not bring about the desired results.

Borrowings of Central Bank

The borrowings o central bank neutralise the effect of open market operations when central bank purchases securities in order to expand credit and money in the economy and if at the same time, central bank borrows from the commercial banks then this will leave the overall cash reserves balance unaffected and open market operations will go unnoticed.

Open Market Operations with Reference to Pakistan:In Pakistan the money and capital markets are not fully developed. Open market Operations are not widely used as a chief instrument of monetary policy. There have been sales and purchases of

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government securities by the cental bank, but these were basically done to provide timely assistance to bank. However despite all this the SBP has an Open Market Operations, committee this committee works under the deputy governor. The committee is response for conducting Open Market Operations in accordance with credit control Policies.

Fiscal Policy FY-2011-2012

While the government restricted growth in its total expenditure during FY11, growth in revenues declined more sharply resultantly, the budget deficit to GDP ratio increased to 6.6 percent in FY11 compared with a target of 4 percent.1 at the time of setting budgetary targets for FY11, the government envisaged not only a considerable containment in its expenditures but also a sharp increase in tax

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revenues (26.2 percent) on the back of a promising set of tax reforms. However, it faced serious setbacks to its budgetary plans due to two unfavorable events: The Federal Board of Revenue (FBR) could not introduce the Value Added Tax (VAT) due to opposition from the business community, and reservations of the provinces. Later, FBR came up with a new proposal, the Reformed General Sales Tax (RGST); however, this too could not be legislated by the parliament. The country faced unprecedented floods in July and August 2010, which called for unplanned allocation of resources for the rescue and rehabilitation of flood victims. Moreover, lower than expected inflows under the Coalition Support Fund and lower SBP profit exacerbated the fiscal stress. On the expenditure side, although overall expenditure was controlled, the government was unable to rationalize subsidies as planned in the budget: actual outlays for subsidies were three times higher than the target of Rs 126.7 billion set for FY11.Perhaps even more troubling is the fact that these subsidies primarily compensate the cost of inefficiencies of public sector enterprises, and their beneficiaries are not necessarily the poor. Although the government started raising electricity tariffs, this was not sufficient to bridge the gap between generation cost and revenue from consumers. The process of phasing out subsidies was too slow to have a meaningful impact on the fiscal The fiscal stress was felt throughout the year even after the introduction of a number of austerity measures and additional revenue generating strategies during Q4-FY11. The budget deficit in the last quarter of FY11 was 2.3 percent of GDP,3 compared with an average of 1.5 percent during the first three quarters. While a large budget deficit was one issue, its financing was another challenge. The government received Rs 107.7 billion in external financing, but this was only 58 percent of the target of Rs.

Inflation and Monetary Policy FY-2011-2012

In spite of active monetary management, FY11 turned out to be yet another year of double digit inflation, fueled by supply side factors including devastating floods at the beginning of the year, and strong global prices of oil and agriculture commodities. On the demand side, massive government borrowing from SBP especially during first quarter of the year added to inflationary expectations. After November 2010, the government switched its borrowing away from SBP towards commercial banks. While this is a welcome development for managing inflationary expectations, it does crowd out the private sector.
The supply constraints not only kept inflation High, but also hurt growth Economic activities were

increasingly disrupted by persisting electricity and gas shortages, heightened security concerns, and increased cost of capital. Both inflation and real GDP growth targets were not met as shown in. Actual annual inflation turned out to be well above the targeted level in FY11 as has been the case since FY06, and real GDP growth remained below the target for five out of the last seven years. Formulating monetary policy in this environment (i.e., low growth and high inflation) is especially demanding since policy measures to contain inflationary pressures entail the risk of further restricting economic activities. Being mindful of these challenges, SBP has vigilantly made use of any possible room available to contain inflation and support economic activities in recent years. In addition to adjusting

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the policy rate, SBP has also been implementing measures to improve its monetary policy framework and to support business activities.

Economic environment ahead of FY112

Before the beginning of FY11, headline inflation was gradually receding during the second half of FY10, while core inflation (non-food non-energy) was hovering at around 10.3 percent. Large scale manufacturing was growing at a modest pace. The current account balance was showing some improvement, supported by healthy exports and robust growth in workers remittances. A sharp increase in cotton prices an export commodity for Pakistan was also observed in the fourth quarter of FY10. In contrast to these positives, fiscal developments proved to be inconsistent with earlier projections since the deficit for FY10 reached 6.3 percent of GDP against a target of 4.9 percent. Inflation for FY10 turned out to be 11.7 percent against the target of 9.0 percent. Furthermore, the government was unable to meet its quarterly borrowing limits from SBP under IMFs Stand-By Arrangement (SBA) program for the third and fourth quarter of FY10. In view of these mixed developments, SBP kept its policy rate unchanged at 12.5 percent in all three monetary policy announcements during the second half of FY10

STATE BANK OF PAKISTAN MONETARY POLICY DECISION FY-2010

The economys ability to achieve sustainable recovery remains constrained owing to slow progress in the prevailing security and economic conditions. The key economic variables impeding stabilization Quaid E Azam School of Management Sciences

and thereby growth are high and persistent inflation, continuing fiscal slippages and unresolved power sector issues. Whereas adjustments in administered prices of fuel and energy and the post-flood disruption in the supply chain of food items have contributed to the recent upsurge in inflation, the high level of government borrowing from the SBP is diluting the effectiveness of monetary policy in containing excessive monetary expansion and thus inflation. The need for such borrowing is largely emanating from a seemingly difficult fiscal predicament. While rising security and flood-related expenditures and continued power sector subsidies are one aspect of the problem, a narrow tax base and a declining tax to GDP ratio are bigger issues magnifying the fiscal challenges. The cost to the economy is being paid through erosion in the purchasing power of the rupee, growing total debt, and discouragement of productive private sector activity. High inflation, at a fundamental level, persists because of money creation in excess of productive activity in the economy. Of the Rs308 billion expansion in reserve money up till 19th November 2010 during the current fiscal year, Rs266 billion is due to government borrowing from the SBP, which has been on an increasing trend since January 2010. Such borrowing has stoked expectations of increasing inflation, resulting in high interest rates. The nature of this fiscal expansion is the fundamental source of high inflation in Pakistan over the last year. Increases in electricity and domestic petroleum prices and the impact of the catastrophic floods on food prices did play their part in providing impetus to CPI inflation but do not fully explain the persistence in inflation. Further, apprehensions that these supply shocks would dramatically worsen the inflation outlook have thus far not fully materialized. Temporary price hikes in the food category, as seen in a monthly increase of over 5 percent during August and September 2010, have somewhat subsided. As a result, in Oct 2010, CPI inflation posted a marginal decline of 0.4 percent on year-onyear basis, while a 0.6 percent growth on month-on-month basis was well below the last 12 months average. On the other hand, the persistent component of inflation, proxied by core trimmed inflation, remains sticky at over 12.5 percent on year-on-year basis since January 2010 and has increased to a 1 percent monthly change in October 2010, with expectations of further increases. An important source of this stickiness is the expectations of a persistent reliance of the government on SBP to finance its deficit. Indeed, the co-movement between persistence of inflation and that of governments financing gap is no coincidence. Therefore, it would be difficult to bring inflation down unless government borrowing from SBP is curtailed substantially and kept under control on a sustained basis.

STATE BANK OF PAKISTAN MONETARY POLICY DECISION FY-2011

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The SBP reduced its policy rate by 200 bps, to 12 percent, in FY12 so far. The objective of adopting this stance is to support revival of private investment in the economy despite a constraining domestic and global economic environment. The primary factors in support of this stance were the expectation of average CPI inflation remaining within the announced target in FY12 and a small projected external current account deficit. In pursuing this stance SBP did acknowledge the risks to macroeconomic stability emanating from fiscal weaknesses and falling foreign financial inflows. These include resurgence of medium term inflationary pressures and challenges SBP is facing in managing market liquidity and preserving foreign exchange reserves. A reassessment of latest developments and projections indicate that macroeconomic risks have somewhat increased during the last two months. For instance, although the year-on-year CPI inflation stands at 11 percent in October 2011, the monthon-month inflation trends, averaging at around 1.3 percent per month during the first four months of FY12, show existence of inflationary pressures. The sifting of commodity level CPI data reveal that the number of CPI items exhibiting year-on-year inflation of more than 10 percent is consistently increasing and almost all of these items belong to the non-food category. The government has also increased its wheat support price by Rs100 to Rs1050 per 40kg for the next wheat procurement season. Thus, while the average inflation may settle around the targeted 12 percent for FY12, it is uncertain that inflation will come down to a single digit level in FY13. The main determinants of this inflation behavior are government borrowing from the banking system and inertial effects of high inflation on its expected path. The severe energy shortages are also holding back the effective utilization of productive capacity and adding to the high inflation-weak growth problem. On the external front, the earlier comfortable external current account position for FY12, which helped SBP in lowering its policy rate, has become less benign. The actual external current account deficit of $1.6 billion for the first four months of FY12 is now higher than the earlier projected deficit for the year. The main reason for this larger than expected deterioration is the rising trade deficit. In particular, the windfall gains to export receipts due to abnormally high cotton prices in FY11 have dissipated faster than anticipated. This is indicated by slightly less than $2 billion per month export receipts in September and October 2011. At the same time, international oil prices of around $110 per barrel and strong growth in non-oil imports have kept the total import growth at an elevated level of close to $3.4 billion per month. Adding to the challenges faced by the external sector is the precarious global economic outlook.

STATE BANK OF PAKISTAN

MONETARY POLICY DECISION FY-2012
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As the economy begins the last quarter of current fiscal year, SBPs monetary management continues to play its part in balancing the implications of multiple challenges faced by the economy. The primary consideration remains bringing inflation further down as it has persistently remained in double digits in the last few years. Ensuring smooth functioning of the payment system and financial stability is also important given the current stressed liquidity conditions in the market. Similarly, elevated international oil prices, weak quantum of exports, and insufficient foreign financial flows require careful management of the external position. Last but not least, the consistent decline in private investment is also an important factor in formulating the monetary policy strategy as it impacts both the medium term inflation, growth and employment prospects. Given limited set of instruments, not all these challenges can be effectively tackled by monetary policy alone. There are bound to be tradeoffs involved among these competing considerations. A supporting fiscal strategy and an active economic reform agenda is critical to deal with some of the structural issues, in particular, low tax to GDP ratio and energy shortages. Most importantly, the economy needs a forward-looking approach to policy making with strict adherence to rules laid out in the legal frameworks, be it the State Bank of Pakistan (Amendment) Act (2012) or Fiscal Responsibility and Debt Limitation (FRDL) Act (2005). Following this approach is crucial in anchoring inflation expectations around the medium term targets of 9.5 percent for FY13 and 8 percent for FY14 as envisaged in the Medium Term Budgetary Framework (MTBF) of the government. In March 2012 the year-on-year CPI inflation was 10.8 percent and, given the current economic conditions, is projected to remain in double digits during FY13. Consistently growing government borrowing requirement from the banking system is a key variable that is adversely affecting the inflation outlook. Weak private demand, on the other hand, is one reason why inflation is not increasing sharply. Nonetheless, the size of fiscal borrowings and lack of investment is eroding the medium term productive capacity of the economy, contributing towards persistence of inflation in early double digits. Another risk factor that needs to be monitored closely for assessing inflationary pressures is the behavior of international oil prices. The current year government borrowings for budgetary support have been Rs373 billion from the scheduled banks and Rs218 billion from the SBP during 1st July 30th March, FY12. The year-onyear growth in these borrowings turns out to be 56.5 percent and 18.5 percent respectively. The yearon-year growth in the private sector credit, on the other hand, was only 4.2 percent and that in total deposits of the banking system was 17.4 percent during the same period. Thus, despite a decent growth in deposits, the banks continue to prefer financing the fiscal deficit as opposed to searching avenues, taking risk, and building partnerships to facilitate credit to the private sector. The cost to the economy is visible in terms of a decline in investment to GDP ratio to historically low levels and stagnant economic growth that is considerably lower than the economys potential.

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