State Bank of Pakistan has just kept its policy rate at 6% for April and May 2018 i.e. before coming elections and budget announcement on the backing 0f achieving an eleven-year high growth rate with average headline inflation within comfortable bounds for FY18 and FY19. This high growth and low inflation outcome has been accompanied by a higher current account deficit. Alongwith a high fiscal deficit, this could affect medium-term stability of the economy.
However, recent adjustments stemming from greater exchange rate flexibility, active monetary management as well as visible improvements in exports and remittances are expected to bear fruit for medium-term in terms of sustaining the growth momentum without posing a risk to stability. CPI inflation has remained moderate during Jan-Feb FY18, averaging 4.1 percent.
The current account deficit has reached USD 10.8 billion during Jul-Feb FY18 which is about 50 percent more than it was during the same period in FY17. Although the full impact of recent exchange rate depreciations on exports and imports is going to unfold gradually in the coming months, financing of the high current account deficit is challenging as a healthy growth in FDI and higher official inflows were insufficient to finance it completely. Consequently, SBP’s foreign exchange reserves declined to USD 11.78 billion as of 22nd March 2018. Going forward, along with a focus on narrowing the current account gap, Government’s plans to timely mobilize external inflows, both official and commercial, will play a pivotal role in maintaining adequate level of SBP’s foreign exchange reserves and anchoring sentiments in the FX markets.
With this question arises that how changes in monetary policy can influence Islamic banks and what is their role in going along with monetary policy objectives.
Despite tremendous growth in Islamic banking and finance globally, it is not easy to convince Pakistani bureaucrats and policymakers that this new form of banking and financial business can potentially be used to run economic and financial matters of the Pakistan economy in a Shariah compliant way.
In fact, a number of sceptics of Islamic banking & finance argue that Islamic financial products are in essence similar to their conventional counterparts and that Islamic banks do nothing but mimic conventional banks. This observation has some merit. Islamic financial products seem to mimic conventional products in terms of pricing and their financial behaviour and economic characteristics. This is primarily because financial regulators treat Islamic products similar to the conventional products and emphasise that the two sets of financial products must not differ much in terms of their risk return profiles and financial characteristics.
Moreover, there is no Islamic-finance-enabling infrastructure in most of the countries where Islamic banking exists. In particular, there are no well-developed Islamic money market operations, except in Malaysia where a number of Islamic money market instruments are developed to allow Islamic banks to have access to liquidity management tools. But even there, a distinct Islamic monetary policy has yet to emerge. This lack of enabling infrastructure is a main reason for mimicking of conventional products in Islamic banking & finance.
It is argued that attempts to develop an Islamic monetary policy may pave way for creating the first vibrant Islamic money markets in the countries where Islamic banking is significant. Pakistan is one such country where Islamic banking is reaching 13 % of the banking sector, yet there is huge dissatisfaction with the current Islamic product offerings, especially by the more conservative religious class that argues for a purist model of Islamic banking. Development of an Islamic monetary policy by the State Bank of Pakistan and implementing it along with its conventional monetary management may give rise to a dual monetary system – something that some people contend to be consistent with the dual banking system as it allows for the parallel operations of Islamic and conventional banks in a country.
It must be emphasised that the suggestion of a dual monetary system is not a far-fetched idea. In fact, there are living examples wherein a country has multiple currencies. In the UK, for example, apart from Bank of England, Bank of Scotland, Royal Bank of Scotland and some other banks issue their own pounds. Malaysia also provides another example, where apart from the main currency Ringgit issued by Bank Negara Malaysia (the central bank), the State of Kalantan also issues gold coins for some of its employees that may wish to be paid in this alternative currency. In fact, any country that allows holding of multiple currencies (as in the form of foreign currency accounts) is technically a multiple currency regime.
The open market operation in monetary management is based on the interest rate mechanism, which makes it clearly and unambiguously Shariah repugnant. Hence, there is a definite and clear-cut need for developing a monetary policy that is in line with the practice of Islamic banking and finance. This will require developing money market instruments that are not based on the interest rate mechanism but rather are based on the Shariah compliant principles and are consistent with the product offerings by Islamic banks. On a more philosophical level, this may lead to a need for creating asset-based money rather than the current debt-based money.