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The State Bank of Pakistan (SBP) is incorporated under the State Bank of Pakistan Act, 1956, which gives the
Bank the authority to function as the central bank of the country. The SBP Act mandates 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.

Subsidiaries of the SBP

The SBP holds two fully owned subsidiaries to augment its functions. These are:

SBP-Banking Services Corporation (SBP-BSC)

Established under the SBP-BSC Ordinance 2001, SBP-BSC supports SBP in performing functions such as
handling of currency and credit management, facilitating the inter-bank settlement system, and
sale/purchase of savings instruments of the Government on behalf of Central Directorate of National
Savings. SBP-BSC also collects revenue and makes payments for and on behalf of the Government. It also
carries out operational work relating to development finance, management of public debt, foreign exchange
operations and export refinance. The Board of Directors of SBP-BSC, chaired by the Governor SBP, comprises
of all members of the Central Board of SBP and the Managing Director of SBP-BSC.
SBP-BSC consists of 16 field offices in Pakistan with the head office in Karachi.
The SBP Banking Services Corporation (SBP-BSC) was established as a wholly owned subsidiary of State Bank
of Pakistan in January, 2002, under the SBP Banking Services Corporation Ordinance 2001.
As an operational arm of the Central Bank, SBP Banking Services Corporation is engaged in managing
currency, foreign exchange operations and foreign exchange adjudication; providing banking services to the
federal and provincial governments and financial institutions regulated by State Bank of Pakistan, conducting
development finance activities in support of the development finance group of the SBP, implementing
export refinance schemes, and performing agency functions like sale/purchase of national prize bonds
including managing prize money draws, sale and purchase of national saving schemes or any other functions
assigned by State Bank of Pakistan.
To develop SBP-BSC into a dynamic and efficient organization equipped with requisite technology and
human resource capable of extending sustainable support to the State Bank of Pakistan in achieving its
To provide excellent banking and financial services to stakeholders besides ensuring implementation of SBP
policies in order to command their trust and respect.

National Institute of Banking and Finance (NIBAF)

NIBAF is the training arm of SBP, providing executive development trainings to new inductees and various
levels of SBP employees. The subsidiary also conducts international courses on central and commercial
banking in collaboration with the federal Government. Furthermore, NIBAF offers training to SBP-BSC and
other financial institutions. NIBAF is incorporated under Companies Ordinance, 1984 and has a separate
Board of Directors.
NIBAF is located in Islamabad with an office in Karachi.

Functions of SBP:
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 non-traditional 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.

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 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.


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.
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 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 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 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
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.


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.

Important Terms
Balance of payments (BoP) is a statistical statement for a given time period showing economic transactions
between residents of the reporting economy with the non-residents.
Balance of trade or trade balance is the difference between the monetary value of exports and imports of
an economy for a specified time period.
Broad money (M2) is one of the various ways to measure the money supply. From liability side, it is
measured as a sum of currency in circulation; total deposits of non-government sector, including residents
foreign currency deposits; and other deposits with SBP. From asset side, M2 is a sum of net domestic assets
and net foreign assets of the banking system (i.e. SBP and scheduled banks).
Call rate is the rate on short-term loans among scheduled banks (ranging from overnight up to fourteen
days) that do not require collateral.
Capital and financial account balance consists of net flows of capital, the long-term funds, both on
government and private accounts; direct foreign investment. It also includes medium and long-term
external debt of the private sector and the government from bilateral, multilateral, commercial sources,
grants and assistance items.
Capital market is that segment of financial markets where lenders and borrowers meet for long term
investments through debt and/or equity financing. It consists of bond markets and stock markets.
Cash in vault (or tills) is the currency held by the scheduled banks in order to meet day-to-day cash
requirements of their customers.
Cash reserve requirement (CRR) is the proportion of total demand liabilities (including time deposits with
tenor of less than 1 year) that scheduled banks are required to maintain with SBP in the form of cash on
both daily basis and 14-day average basis.
Clean rate is the rate on short-term loans at which financial institutions lend/borrow among themselves
without any underlying collateral.
Consumer price index (CPI) is main measure of price changes at retail level. It measures the changes in the
cost of buying representative predefined basket of goods and services and to gauge the increase in the cost
of living in reporting period.
Contractionary monetary policy refers to central banks actions aiming to reduce systems liquidity or to
increase policy rate and thereby other interest rates. The contractionary monetary policy, which is also
known as monetary tightening or tight monetary policy stance, is generally adopted by SBP to contain
inflationary pressures in the economy.
Core inflation is defined as a persistent or underlying long-term component of inflation and is generally
computed by excluding certain items that face volatility in their prices.
Coupon rate is the interest rate payable on bonds par value at specific regular periods. For instance, in case
of Pakistan Investment Bonds returns on coupon rate are paid on biannual basis.
Credit is a financial agreement in which a borrower receives a sum of money (or asset) that is agreed to be
paid back in a future date, generally with an added interest amount.
Current account is a record of all transactions in the balance of payments covering the exports and imports
of goods and services, payments of income, and current transfers between residents and nonresidents.
Currency in circulation refers to currency held by public i.e. currency outside the banking system.
Current deposits refer to deposits in a bank account without any maturity date and generally banks pay no
return on these deposits.
Cut-off rate is the interest rate decided by the Ministry of Finance at or below which the bids for
government papers (T-bills, PIBs) are accepted in the primary auctions of government securities.
Debt refers to outstanding financial liabilities arising from past borrowings. Debt may be owed to external
or domestic creditors and typically, debt financing is in the form of loans or bonds.
Debt rescheduling is undertaken through an agreement between the borrower and the creditor to re-
arrange the schedule of principle and interest payments due on the debt outstanding. Rescheduling
agreement may also include provisions for debt relief to enable the borrower to regain its financial strength
to service the rescheduled debt obligation.
Debt servicing refers to scheduled payments of interest and principal amounts (amortization) due on the
outstanding amount of debt during a specific period.
Deflation is a decrease in general price level in an economy over time; i.e., the decline in a price index over
a specific period of time.
Depreciation of currency refers to decrease in value of the domestic currency vis--vis foreign currency due
to changes in demand and supply of the foreign exchange. Currency depreciation required the buyers of
foreign exchange to pay more domestic currency units to buy a unit of foreign currency than before.
Direct tax is a tax levied directly on the taxpayer such as income and property taxes.
Domestic debt refers to the debt owed to creditors resident in the same country as the debtor. It can be of
sovereign nature, i.e., borrowed by a government or non-sovereign, i.e., borrowed by the corporate.
Sovereign domestic debt in Pakistan is further classified into three main categories: permanent debt,
floating debt and unfunded debt.
Economic growth is the increase in economic activity during a particular period, normally a year, measured
as percentage change in GDP (or GNP) of a country.
Excess (cash) reserve is the amount of cash held by banks, with SBP, over and above the cash reserve
requirements. In general, increase in excess reserve indicates easy market liquidity conditions, and vice
Exchange rate is the value of a unit of foreign currency in terms of domestic currency, or vice versa.
Expansionary monetary policy refers to central bank actions aiming to increase systems liquidity or lower
policy rate thereby reducing other interest rates. Expansionary monetary policy, also known as monetary
easing or adopting a loose monetary policy stance, is generally used to stimulate economic activity during
External debt , at any given time, is the outstanding amount of those liabilities that require payment(s) of
principal and interest by the debtor at some point(s) in the future and that are owed to nonresidents by the
residents of an economy.
Face value is the value of a bond that is redeemed to the owner/subscriber of that security at the time of
Financial account is part of overall Balance of Payment that records all transactions associated with changes
of ownership in foreign financial assets and liabilities.
Fixed deposits are the deposits having fixed maturity dates and a rate of return determined by the bank.
Floating domestic debt of government consists of short-term borrowing in the form of T-bills.
Foreign direct investment refers to the acquisition of at least ten percent of the ordinary shares or voting
power in a public or private enterprise by nonresident investors. Direct investment involves a lasting
interest in the management of an enterprise and includes reinvestment of profits.
Foreign exchange market is the segment of the financial markets that deals with the trading of foreign
currency among various market players like banks, exchange companies, central bank, investment
management firms, brokerage houses and other corporate concerns.
Foreign exchange net open position of a bank is the difference between banks foreign currency assets and
liabilities at a given point in time. When the assets are in excess, the NOP is long, and when liabilities are in
excess, NOP is short. Foreign exchange reserves are the claims of the banking system on nonresidents,
including central banks holding of gold, SDRs, foreign currencies, deposits in foreign exchange abroad,
investments in debt instruments of other countries, and the country's reserve position in the IMF.
Foreign exchange (forex) swap is a contract between two parties to exchange two currencies at an agreed
exchange rate and reverse the transaction at a certain point in time in future at an agreed exchange rate.
Foreign inflows are the countrys total receipts in foreign exchange irrespective of the source such as
exports, remittances, foreign investment or loans.
Gross domestic product (GDP) represents the total value of final goods and services produced within a
country during a specified time period, such as a fiscal year. It is the most commonly used single measure of
a country's overall economic activity.
Gross national product (GNP) is the value of all the goods and services produced in an economy, plus net
factor income from abroad.
GNP per capita is calculated by dividing total GNP by total population of the country and shows the income
earned per head or value of goods and services produced per head during a particular year by an individual
of the country. Hyperinflation is a rapid increase in general price level. There is no consensus on the rise in
price level that is considered as hyperinflation. Inflation rate of greater than 50 percent per month is
thought of as hyperinflation in some literature.
Indirect tax is a tax levied on goods or services rather than individuals and is ultimately paid by consumers
in the form of higher prices such as sales tax or value added tax.
Inflation is a sustained increase in average prices of goods and services in an economy over time. Inflation
also means loss in the value of money i.e. the quantity of goods and services that can be purchased with a
certain amount of money.
Interbank market is the market where financial institutions trade financial assets or cash amongst
Interest rate is the price that is paid to convert future income to current consumption or an incentive to
postpone current consumption for higher consumption in future. Simply, it is the rate charged by the lender
to the borrower for the use of money for a specific period of time, usually expressed on annual terms.
Investment, from the perspective of the domestic economy is the purchase of capital equipment, e.g.,
machines and computers, and the construction of fixed capital, e.g., factories, roads, housing, that serve to
raise the level of output in the future.
Karachi inter-bank offered rate (KIBOR) are i nterbank clean (without collateral) lending/borrowing rates
quoted by the banks on Reuters. The banks under this arrangement quote these rates at specified time i.e.
11:30 am at Reuters. Currently 20 banks are members of KIBOR club and, by excluding 4 upper and 4 lower
extreme, rates are averaged out and quoted for both ends viz: offer as well as bid. The tenors available in
KIBOR are one week to 3 years. KIBOR is used as a benchmark for corporate lending rates.
Market related treasury bills (MRTBs) are treasury bills of 6-month tenor through which government
borrows from SBP at the weighted average rate of 6-month T-bill decided in the latest primary auction.
Market treasury bills (MTBs) are the short term debt instruments of the Government of Pakistan with
tenors available in 3, 6 and 12 months. They are sold through Primary Dealers in auctions held on fortnightly
basis. They are zero-coupon securities and are sold at discount.
Money refers to anything that is generally accepted in exchange as payment for goods and services. The key
functions of money are to act as a medium of exchange, store of value, unit of account, and standard of
deferred payment. Money market is the segment of financial markets where banks and non-bank financial
institutions lend or borrow funds in local currency amongst themselves for short period.
Money multiplier is the ratio of stock of broad money (M2) to the stock of reserve money or monetary base
(M0). It tells us what multiple of the monetary base is transformed into the money supply.
Multiple price auction is an auction mechanism in which successful bidders pay the price equivalent to the
rate or yield they bid.
Narrow money (M1) is an indicator used to measure money supply in the economy and includes currency
notes in circulation, other deposits with State Bank of Pakistan, and demand deposits (including resident
foreign currency deposits) with scheduled banks.
Nominal anchor is an economic variable that relatively quickly adjust to changes in monetary policy
instruments and have a predictable relationship with the ultimate policy objectives, such as inflation and
economic growth.
Nominal effective exchange rate ( NEER) is an index representing the relative nominal value of one
countrys currency compared with the combined effect of weighted basket of currencies of its major trading
partners. The weight is determined as home countrys share in imports, exports or total foreign trade with
major trading partners.
Output gap is the difference between actual output of the economy and the output that could be achieved
by efficiently utilizing all available resources (also termed as potential output)that is when the economy is
operating at its full capacity.
Outright OMO is a transaction whereby government securities (mainly T-bills) are bought or sold by SBP for
a tenor equal to remaining maturity of the securities.
Pakistan investment bonds (PIBs) are the long term debt instruments of the government of Pakistan with
tenors available in the range of 3 to 20 years. PIBs are sold through primary dealers (i.e., institutions
appointed by the SBP to participate in government securities primary auctions) in auctions as and when
announced (on quarterly basis). These are coupon bearing instruments and issued in scrip less (without
physical) form. Interest on PIBs is paid on biannual basis.
Pakistan revaluation (PKRV) rate is average of the yield-to-maturity on government securities traded in the
secondary market and determined at the end of day. The yield-to-maturity on government securities is
quoted by the six brokerage houses keeping in view the yield-to-maturity on government securities traded
in the secondary market. These brokers are selected by Financial Market Association of Pakistan. PKRV is
used by banks and other institutions to revalue their holdings of government securities on a daily basis.
Permanent debt includes medium and long-term debt such as Pakistan Investment Bonds (PIB) and prize
Potential output or productive capacity of the economy is the maximum amount of goods and services that
can be produced by a country by utilizing all of its resources, i.e. labor, capital equipment, time, natural
resources, and technology, etc. Alternatively, it shows the level of output which can be sustained in the long
Primary dealers are the list of financial institutions that are eligible to participate in the primary market of
auction of government securities.
Primary market the market that deals with the issuance of new securities and bonds, such as the auctions
of T-Bills, PIBs and Ijara Sukuk, to a select group of banks and non-banks, known as primary dealers.
Public sector enterprises (PSEs) are the organizations that are controlled by the government, exercised
through ownership of more than half the voting shares, legislation, decree, or regulations that establish
specific corporate policy or allow the government to appoint the directors and providing goods & services
on a market basis.
Purchasing power parity is a theory which relates changes in the nominal exchange rate between two
countries currencies to changes in their price levels. The purchasing power parity theory suggests that an
increase in a currency's domestic purchasing power will be associated with a proportional currency
appreciation, and that a decrease will be associated with a proportional currency depreciation.
Real appreciation is an increase in the real exchange rate, due to changes in domestic prices, foreign prices,
or the nominal exchange rate, as a result of which the price of domestic goods increases relative to the price
of foreign goods. In other words, when a unit of domestic good can be exchanged with more units of a
foreign good, this is called real appreciation.
Real depreciation is a decrease in the real exchange rate, due to changes in domestic prices, foreign prices,
or the nominal exchange rate, as a result of which the price of domestic goods decreases relative to the
price of foreign goods. In other words, when a unit of domestic good can be exchanged with less units of a
foreign good, this is called real depreciation.
Real effective exchange rate (REER) is an index used to determine the relative value of one countrys
currency compared with the combined effect of weighted basket of currencies of its major trading partners
as adjusted for the effects of inflation.
Real interest rate is nominal interest rate minus expected inflation for a year ahead.
Realized value is the amount received by a borrower against issuance of a debt instrument. For example,
the discounted value of a treasury bill sold in an auction is the realized value of this security for the
Repo rate is the interest rate at which scheduled banks lend/borrow among themselves against approved
government securities (T-bills and PIBs).
Repo transaction is the simultaneous sale of securities (such as T-bills and PIBs) with an agreement to
purchase it back in future at a predetermined date and price.
Reserve money (M0) is a measure of money supply in the economy. From liability side it includes currency
in circulation (held with Public), other deposits with State Bank of Pakistan; currency in tills of schedules
banks, and bank deposits with SBP to meet cash reserve requirements. From assets side, M0 is used to
measure the most liquid assets which can be spent most easily. M0 is sometimes referred to as the
monetary base.
Reverse repo transaction is the reverse of the repo transaction. It is defined as the simultaneous purchase
of securities with an agreement to sell it back in future at a predetermined date and price.
Secondary market is the market that deals with trading of bonds and securities already issued through
primary auctions or initial public offering (IPO).
Sensitive price indicator (SPI) is computed on weekly basis to assess the price movements of essential
commodities at short intervals so as to review the price situation in the country.
Sovereign debt: A debt instrument issued by a sovereign. Most sovereign debt takes the form of bonds.
Term finance certificates (TFCs) are the debt instrument issued by corporate sector to meet a part of their
long-term financing needs.
Terms of trade shows the change in the average price of a countrys aggregate exports in relation to the
change in average price of its imports.
Time inconsistency problem is a condition in which preference of an entity changes over time and becomes
inconsistent with the decisions taken at a prior time period. For instance, a good example is of a central
bank that signals the market that it would hike the policy rate in case of high inflation. However, when such
a situation arises, it reneges to its commitment to take that decision.
Unfunded debt refers to outstanding debt raised by the government through various national saving
schemes (excluding prize bonds).
Uniform price auction (or fixed rate tender)is an auction mechanism in which the cut-off rate of auction is
applicable for all the bids received in that auction, for e.g. GoP Ijara Sukuk.
Variable rate tenders refers to a tender procedure whereby the counterparties bid both the amount of
money they want to transact with the central bank and the interest rate at which they want to enter into
the transaction.
Weighted average deposit rate is the weighted average of interest rates on deposits (demand deposits,
time deposits, and resident foreign currency deposits) using share of corresponding deposit amount to total
deposits as weight.
Weighted average lending rate is the weighted average of interest rates charged by banks on loans using
share of the corresponding loan amount to total loans as weight.
Weighted average money market overnight repo rate is the weighted average of interest rates on
overnight repo transactions, using share of respective transactions in total amount as weights.
Wholesale price index(WPI) is designed to measure the changes in prices of a set of selected items in the
primary and wholesale markets. Items covered in the series are those, which could be precisely defined and
are offered in lots by producers/manufacturers. Prices used are generally those, which conform to the
primary sellers realization at ex-mandi (market), ex-factory or at an organized wholesale level.
Workers remittances are current transfers for family maintenance by migrants who are employed and
residents in other countries. (A resident is a person who stays, or is expected to stay for a year or more in an
Yield curve is the graphical representation of relationship between the interest rate and the maturity time
of a given debt instrument. Typically, the yield curve is upward sloping which means that assets with longer
term maturity will be associated with higher interest rates.

What is money?
Money is any asset or a good that is readily acceptable for making payments against the purchase of goods
and services or settling debt obligations. For example, currency notes, coins, and cheques drawn against bank
deposits are the most common forms of money used by an average Pakistani to carry out their day-to-day
transactions. Recently, payments through credit and debit cards are gaining popularity. However, their
acceptability is restricted to main cities and towns only.
Money can also be thought of as a special asset or good that could perform three basic functions viz. medium
of exchange, unit of account, and store of value. For this reason, it is sometimes stated that money is what
money does.

How is money created?

Money is usually created when SBP either buys domestic assets, mainly government securities, and foreign
exchange from the banking system or directly lends to the government or financial institutions. For example,
when SBP buys government securities through its open market operations from the interbank market, it gives
banks equivalent rupee liquidity in return; which banks use to create more assets, such as loans to private
and public sectors. The money thus created is called base money, seed money,high powered money, or
reserve money.
Since most of the loaned funds are later re-deposited into the banking system and banks keep only a fraction
of deposits in cash in tills or reserves with the SBP, it allows banks to make further lending and create
additional money by multiplying the base money. Deposits and assets of banks are expanded and therefore
broad money increases in the system.

How is money supply measured in Pakistan?

There are several ways to measure money supply in an economy depending upon different degrees of
liquidity that different types of monetary assets have. Money supply is generally measured as a sum of
currency in circulation and deposits of general public in different financial institutions.
In Pakistan, M2 is the most widely used definition of broad money. From liability side, it is measured as a sum
of currency in circulation; total deposits of non-government sector, including residents foreign currency
deposits; and other deposits with SBP. And from asset side, M2 is a sum of net domestic assets and net
foreign assets of the banking system (i.e. SBP and scheduled banks).
In addition, data from liability side of a narrower definition of money as M1 and a broader definition of
money as M3 are being regularly complied and published by SBP. M1 is defined as a sum currency in
circulation, demand deposits with banks, and other deposits with SBP. M3 is measured as M2 plus public
deposits or investment in national saving schemes, deposits with post offices, and non-bank financial
Why is it important to monitor growth in money supply?
There exists a strong and positive correlation between inflation and monetary growth in Pakistan in a long
term perspective. A number of empirical studies concluded that high inflation is associated with high
monetary growth in the country in the long-run. Therefore, to achieve the objective of maintaining low and
stable inflation, it is essential to monitor the growth in money supply as an important indicator for monetary
There is no defined level of monetary growth that is suitable for all time. Rather it depends on overall
economic conditions in the country, in particular levels and trends in inflation and economic growth.

How does SBP influence money supply in the system?

SBP mainly influences the broad money growth by changing its monetary policy rate, conducting open
market operations and foreign exchange SWAPs, and modifying cash reserve requirements for the scheduled
banks. A cut in the policy rate, followed by appropriate liquidity management, transmits to bank lending rates
with a lag and may induce demand for credit and broad money in the economy. Similarly, with low reserve
requirements, banks are able to loan more money, which may increase the overall supply of money in the

Interest Rates in Pakistan

How does SBP influence long-term interest rates and banks lending and deposits rate?
SBP signals its monetary policy stance through changes in its policy rate known as the SBP reverse repo rate.
SBP aims to keep the overnight interbank repo rate within the 250 basis points corridor set by the SBP
reverse repo rate as its ceiling and SBP repo rate as its floor with effect from 11 th February 2013.
SBP influences long-terms rates by exploiting their relationship with short-term rates. In general, the long-
term interest rates reflect the average expected future level of short-term interest rate plus a term premium
to compensate for uncertainties. Changes in the policy rate influence the long-term interest rate through its
impact on short-term interest rates, term premium, and inflation expectations. Demand and supply of
loanable funds also play a vital role in determination of interest rates in the market.
Lending rates of banks are linked to a benchmark rate known as Karachi Interbank Offered Rate (KIBOR),
which is published by Financial Market Association of Pakistan. SBP has mandated banks to benchmark their
lending to the corporate sector to KIBOR, so that the pricing mechanism is transparent.
Deposit rates are largely market driven; nonetheless, State Bank of Pakistan has set a minimum rate on
saving deposits (which are approximately one-third of total deposits) to safeguard the interest of depositors
and to avoid a high lending-deposit spread.

Understanding Inflation
What is inflation? How is inflation measured in Pakistan?
Inflation is a sustained rise in general price level in an economy over time. It also indicates a decline in the
purchasing power of money over time; i.e. a certain amount of money buys less and less over time than it
used to do earlier. For example, the price of one kg of wheat, one kg of basmati rice and one litre of milk was
Rs24 in July 1991, which has increased to Rs.226 in May 2013. This shows that the purchasing power of
money has significantly declined during 1991-2013.
Pakistan Bureau of Statistics (PBS) compiles and publishes data of various measures of general price levels in
Pakistan; including consumer price index (CPI), wholesale price index (WPI), sensitive price indicator (SPI),
and GDP deflator. CPI, WPI, and SPI are compiled on monthly basis, while the data on GDP deflator is
published on annual basis. SPI data is also available at weekly frequency.
CPI is the most commonly used measure of general prices to analyze inflation in the country. Inflation targets
are set in terms of an annual change in CPI on average basis for a fiscal year. The CPI records weighted
average change, with respect to a base year, in the prices of a basket of goods and services such as food,
housing, fuel, transport, clothing, furniture, education, medicines and entertainment etc that a typical
Pakistani consumer purchases. The weight attached to a particular item in the CPI basket, e.g. milk, is
derived as ratio of average spending by the households on purchase of milk to average expenditure of the
households. Family budget survey, periodically conducted by PBS, provides the basis of selecting items and
their respective weights in the CPI basket.
Details on the methodology of data compilation of price indices are available on PBS website.
What causes inflation in Pakistan?
There are several factors that can affect inflation on a temporary or a permanent basis. For instance, a
relatively higher growth in aggregate demand of goods and services than of its supply; upward adjustment in
administered prices such as utility prices; rise in international commodity prices such as oil; supply-side
disruptions due to natural calamities such as floods and earthquake; depreciation of local currency vis--vis
other currencies; etc are some of the factors that can spur inflation at least in the short-run.
A large number of empirical studies find growth in money supply as one of the most important determinants
of long-term inflation in Pakistan. This is in line with theoretical underpinnings and empirical results for
inflation in many other countries. This is why inflation is often described as too much money chasing too few
goods. In other words as the money supply in an economy exceeds the amount needed for financial
transactions, aggregate demand outpaces the production of goods and services. As an outcome, inflation
increases and the purchasing power of a local currency unit declines.
In the studies on inflation in Pakistan, fiscal deficit, government borrowings from SBP, exchange rate
depreciation, international commodity prices are some other factors that are found to play a significant role
in determining long-term inflation in the country.

Why is high inflation bad?

High inflation makes maintaining a standard of living difficult because it erodes the purchasing power of
money in terms of amount of goods and services one could buy. It also undermines the use of money as a
store of value. High inflation can severely affect the normal working of an economy and is usually detrimental
for sustained economic growth. At times, high inflation is also accompanied by increased volatility in prices of
goods and services. It creates uncertainties and affects the decisions of households and businesses to
consume, save, or invest.
It particularly discourages investment, which has negative implications for sustaining higher economic growth
over long-run. Uncertainty about future prices makes businesses hesitant to make investment decisions. This
is because volatility in inflation makes it difficult for businesses to anticipate the prices of the products they
plan to produce now and which would make their way into the market in future. Similarly, high and volatile
inflation confuses consumers about spending now or postpone it to some latter date. Ultimately, it reduces
overall spending in the economy that starts hurting economic activity in the short run.
Higher domestic inflation compared to inflation in countries which are our trading partners or competitors
also erodes competitiveness of our exports and imports, thus negatively affecting the trade deficit the gap
between receipts against export of goods and payments against imports, all expressed in foreign currency.
Higher inflation increases the prices of raw material as well that pushes up domestic cost of production. This
makes our exports costly relative to our competitors in our export destination countries. Therefore, growth in
exports slows down leading to widening of trade deficit.
Prolonged inflation also affects income distribution in the country negatively, particularly affecting the poor
by redistributing wealth to the riches that have non-money assets, such as land or gold.

Why shouldnt SBP attempt to bring inflation down to zero?

Some inflation is always necessary for incentivizing the businesses to invest and produce more, creating
employment opportunities for the new entrants in the labor market. There are at least four reasons cited
against targeting zero inflation
First, as widely believed, there is an upward bias in the measurement of CPI inflation and targeting zero
inflation might run the risk of deflation in the economy. In other words, after adjusting for the impact of
improvement in quality of goods and services over time, the rate of increase in adjusted price level might
even decline on average across the economy.
Second, given downward rigidity in wages, no inflation would lead to a rise in real wages making adjustments
in the labor market difficult. Low inflation, however, might allow some flexibility and wages might not rise in
relative terms.

Third, bringing inflation down to zero is costly in term of required contraction in economic activity and
employment in the economy.
Fourth, as nominal interest rates cannot be negative, keeping inflation at zero make the monetary policy
ineffective when interest rates fall close to zero. A central bank cannot stimulate economic activity during
recession unless there is some inflation so that reducing interest rate could turn the real interest rates
negative and thus encourage people to spend more.

Understanding Monetary Policy.

What monetary policy can and cannot achieve?
There is a general agreement among economist that monetary policy can stimulate economic activity only in
short-run and under certain condition, i.e. economy is operating below its potential level and inflation is low.
It is widely experienced that attempts to increase growth beyond what an economy can sustain, with its
given resources and technology, through expansionary monetary policy result in high and volatile inflation;
which have negative repercussions for long-term economic growth.
Given limited influence of monetary policy on growth in the long-run, what monetary policy actually strives is
to align demand in the economy close to its productive capacity. For instance, when economy is in recession
and working below its productive capacity, a n expansionary monetary policy would tend to increase
aggregate demand in the economy. For instance, the expansionary monetary policy increases incentives for
households and businesses to borrow more by reducing their cost of borrowing from commercial banks.
Through this way, demand for goods and services increases in the economy, and firms respond to this
increased-demand by increasing their production and thus requiring more raw material, labor and machinery.
However, if money supply continues to increase, and thus demand for goods and services, the prices start to
rise at a faster pace and result into higher inflation.
In short, monetary policy has a lasting effect on inflation but only a transient impact on economic growth.

What is the role of monetary policy in promoting economic growth?

Both literature and central bank practices show that the best contribution monetary policy can make to
sustainable growth and employment generation over the long run is by keeping inflation low and stable. By
maintaining price stability, monetary policy reduces uncertainty about prices changes and provides an
economic environment that allows the economy to expand in line with its production capacity. The literature
also shows that low and stable inflation is pre-condition for securing growth prospects over the medium and
long term.
If monetary policy can stimulate economic activity in a recession, why not use it all the time?
There is a certain level of growth an economy can achieve in the long run utilizing all of its available
resources, which is referred to as the long run growth potential of the economy. When an economy operates
below its long run growth path, it means that the economy is not utilizing its full potential and some
resources are idle. Under such a situation, loose monetary policy could boost domestic demand and push
growth towards the long run growth path. However, any attempt to expand growth beyond the long run path
only results in inflation without any significant increase in output and employment in the economy.

Why doesnt SBP simply print enough money to pay off national debt?
Printing money to pay off the national debt will cause inflation and effectively reduce the value of domestic
money. This is because it will add to money supply in the economy without a matching increase in production
of goods and services. This could even lead to hyper inflation, which has negative repercussions for economic
growth and overall well being of the people. Furthermore, the increase in money supply of rupee against
other currencies would also cause the rupee to depreciate.
Germany is a classic example where large scale printing of money was done to pay off their restitution
payments after the First World War. This led to rampant inflation from 1922-24 and left the Deutcshe Mark
worthless: people literally used notes to lit fires. Recently, Zimbabwe is faced with a similar situation.

What can monetary policy do in case inflation is caused by supply shocks only?
Monetary policy can prevent effects of the supply shocks affecting a particular segment of the CPI basket to
become wide spread and broad based over time. For instance, a supply shock leading to a sharp increase in
food prices, due to increase in international commodity prices, floods, droughts, etc., might make it difficult
for factory workers in managing to fulfill bare needs of their families of average size. Therefore, the labor
union would press the factory management for increasing their wages and salaries. This results in increased
cost of production and as businesses usually pass these on to consumers, prices of the goods they produce
rises further. This is known in the literature as the second round effect. Thus, inflation may further go up.
An increase in interest rate (if necessary) can stop potential second round effects of such supply shocks on
inflation. Depending on credibility of the central bank, the increase in interest rate in the first place would
help in calming the expectations of rise in prices of other commodities of CPI basket. With the expectation of
compensation in terms of fall in prices of other segment of the CPI basket, there will be lesser pressures on
wages and salaries, thereby, contributing to decline in inflation in future.

Why does SBP focus on price stability?

Research shows that keeping inflation low and stable creates a favorable environment for sustaining high
growth and generating employment opportunities in the long run. It also helps in preserving the domestic
value of money and fostering confidence in national currency. These reduce uncertainties about future
movements in prices of goods and services and facilitate consumers and businesses to make long-term
financial decisions with more confidence. Thus price stability supports long-term investment, which is critical
for employment generation and efficiency and productivity in the economy. Moreover, low and stable
inflation help businesses to maintain competitiveness in both the local and international markets. It also
protects the purchasing power of low and fixed income segments of society, whose savings are in cash rather
than real assets.

--Summary of Economic survey of Pakistan 2016-17-- GDP 5.28% Agriculture 3.46 %, 19.5% share in GDP,
42.3% of the labor force Industrial sector 5.02 %, 20.9 % share Services sector 5.98 % 59.6 % share
Investment 1.28% 15.78% Total Investment Rs 5027 billion Investment to GDP ratio 15.78% National
savings 13.1% of GDP Per capita income $1629 Fiscal deficit 4.6% of GDP trade deficit US$ 17.8 billion in
July-March FY2017, Current Account deficit 2.38 % of GDP Interest Rate (policy rate) 5.75% Inflation
4.1% Core Inflation 5.1 Education 2.3% Remittance 2.79% Revenue 15.3% Exports 16.1 billion dollars
Foreign exchange reserves 21.36 billion dollars PSX reached 52000 points 15 may 2017 Pakistan Stock
Exchange was ranked the fifth best performing stock market in the world.