CENTRAL BANK AS REGULATOR

Overview

The Financial Institutions Supervisory Division (FISD) has supervisory responsibility for
deposit-taking institutions licensed under financial legislation administered by the Central Bank,
commercial banks, licensed near-banks such as merchant banks, trust companies and finance
houses and building societies. These responsibilities involve continuously assessing the quality
of licensees‟ operations and financial condition and ensuring that each
Licensee possesses an appropriate level of technical, financial and personnel resources at its
disposal to ensure efficient, prudent, sound and profitable operations on an ongoing basis. The
Supervisory Authority legally comprises the Governor as Supervisor and the Deputy Governor a s
Deputy Supervisor of Banks and Financial Institutions, supported by the staff of the Financial
Institutions Supervisory Division. Major Powers and overall responsibilities reside with the
Minister of Finance, for example, the power to grant and revoke licenses, make regulations and
vary prohibitions/restrictions imposed by legislation and responsibility for reporting to
Parliament. The impact of the Bank of Jamaica in this area is restricted to the role of making
assessments and recommendations.

Why Regulate

There are two primary reasons why central; bank regulates and supervises licensees:
To promote their safety and soundness so as to protect confidence in and Integrity of the
banking system and the interests of depositors.
To promote an efficient and effective banking system that finances economic growth,
allocates credit and meets the needs of the customers and communities they serve.

Supervision of these deposit-taking entities is necessary, as the main source of funding for their
loans and investment activities is the savings and deposits of members of the public. It is
internationally recognized that banks and other deposit-taking institutions are the repository of a
nation‟s wealth and, as such, regulation that demands prudence and sound financial practice to
ensure the safeguarding of that wealth is a feature of all stable economic environments.

“Regulators do not manage banks and other financial institutions and cannot
Assume responsibility for their proper management - that is the sole
Responsibility of the board of directors and senior management”
Consequently, the Regulator cannot always prevent the failure of a financial institution. The
Regulator‟s responsibility is to take action to protect the interests of the financial system and by
extension, the interests of depositors. In other words the Regulator must always work to ensure
that failure of one banking entity (or perhaps more) does not cause or result in the failure of
several others, thus putting at risk the safety and soundness of the entire system and threatening
the well-being of the economy as a whole.

Who Supervise

The supervised population comprises entities governed by the following pieces of legislation:
The Banking Act, 1992 (as amended 1997) – commercial banks
The Financial Institutions Act, 1992 (as amended 1997) – merchant banks, finance
houses etc.
The Building Societies Act and The Bank of Jamaica (Building Societies) Regulations,
1995 – building societies

Among the issues assessed are:

Whether the proposed shareholders, directors and management of the institution seeking
licensing meet the “fit and proper” criteria
The adequacy of capital resources of the applicant – to ensure a sufficiency of such
resources to the licensed institution on an ongoing basis
Management expertise available to the entity
Business plans and financial projections of the entity

What Supervise

In fostering the objectives of safety and soundness in the financial sector the Supervisory
Authority assesses:

How much risk each licensee is undertaking.

Resources available to manage these risks - these may be tangible (capital) or intangible
(internal control systems, management experience and competence).
Whether the identified level of resources are sufficient to manage the risks.

Typical Risks

The typical risks faced by licensees are:

Credit risk – the risk that the licensee‟s borrowers might not pay on the due date
Liquidity risk – the risk that the licensee might itself fail to meet its obligations when
they fall due
 Yield risk – the risk that the licensee‟s assets may generate less income than the expense
generated by its liabilities
Market risk – the risk of loss resulting from movements in the market price of financial
instruments in which the licensee has a position
Operational risk – the risk of a failure in the licensee‟s procedures or controls
Ownership/management risk – the risk that shareholders, directors or senior
management may be unfit for their respective roles or actually be dishonest.
Other risks – for example, threats of money laundering, fraud and theft, among others.

How Supervise

Essentially, the Supervisory Authority has sought to achieve its goals by:

Ensuring that licensees comply with all applicable laws and regulations including the
imposition of new regulations where the necessity arises
Enforcing guidelines and performance standards
Providing guidance through Best Practice standards
Verifying and assessing the quality of licensees‟ activities through annual on-site
examinations and ongoing off-site monitoring
Seeking to achieve as much disclosure as is possible.

Although regulations and guidance are important, the cornerstone to a bank supervisory process
is through on-site examinations conducted at least once annually, along with off-site surveillance
on an ongoing basis. On-site examinations refer to supervisory review activities of actual
operations of the licensee carried out at its place of business. The process involves the collection
of on-the-spot information that will indicate the current financial condition of an institution and
the situation prevailing in its various operational areas/portfolios, verification of financial data
already furnished to the Bank and a review of its compliance with laws, regulations and
standards of best practice.

Assessments will of necessity have a major concentration on credit and investment portfolio
quality, these being the areas where the highest risk of loss is encountered. However greater
focus is being placed on the quality and adequacy of risk management systems in the key areas
of an institution‟s operations, such as capital adequacy, asset portfolio management, Earnings,
liquidity, internal controls and overall management. Off-site supervision provides an important
complement to on-site examination by providing early earning of actual or potential problems,
and a means of assessing broader patterns and trends within the system as a whole. For example,
The Bank of Jamaica‟s off-site supervision process involves a number of steps. These are:

Data collection and verification checks

 Data analysis
Reporting of findings (up to the Governor and Minister)
Recommendations for corrective action
Monitoring of appropriate implementation of corrective action

Data are obtained from a variety of sources, the primary one being regular Prudential returns
(weekly, monthly, quarterly and annually), which are specified in the governing financial
legislation.

FRACTIONAL RESERVE BANKING

Fractional-reserve banking is the banking practice in which banks keep only a fraction of their
deposits in reserve (as cash and other highly liquid assets) and lend out the remainder, while
maintaining the simultaneous obligation to redeem all these deposits upon demand. Fractional
reserve banking necessarily occurs when banks lend out any fraction of the funds received from
deposit accounts. This practice is universal in modern banking.

By its nature, the practice of fractional reserve banking expands money supply cash and demand
deposits beyond what it would otherwise be. Because of the prevalence of fractional reserve
banking, the broad money supply of most countries is a multiple larger than the amount of base
money created by the country's central bank. That multiple called the money multiplier is
determined by the reserve requirement or other financial ratio requirements imposed by financial
regulators.

Central banks generally mandate reserve requirements that require banks to keep a minimum
fraction of their demand deposits as cash reserves. These both limits the amount of money
creation that occurs in the commercial banking system, and ensures that banks have enough
ready cash to meet normal demand for withdrawals. Problems can arise, however, when a large
number of depositors seek withdrawal of their deposits; this can cause a bank run or, when
problems are extreme and widespread, a systemic crisis. To mitigate these problems, central
banks or other government institutions generally regulate and oversee commercial banks, act as
lender of last resort to commercial banks, and also insure the deposits of the commercial banks'
customers.

History

Back to the 1800s, savers looking to keep their valuables in safekeeping depositories deposited
gold coins and silver coins at goldsmiths, receiving in turn a note for their deposit. Once these
notes became a trusted medium of exchange an early form of paper money was born, in the form
of the goldsmiths' notes. As the notes were used directly in trade, the goldsmiths observed that
people would not usually redeem all their notes at the same time, and they saw the opportunity to
invest their coin reserves in interest-bearing loans and bills. This generated income for the
goldsmiths but left them with more notes on issue than reserves with which to pay them.

Reason for Existence

Fractional reserve banking provides benefits to the economy and the banking system. The fact
that banks are required to keep on hand only a fraction of the funds deposited with them is a
function of the banking business. Banks borrow funds from their depositors and in turn lend
those funds to the banks‟ borrowers. Banks make money by charging borrowers more for a loan
i.e. a higher percentage interest rate than is paid to depositors for use of their money. If banks did
not lend out their available funds after meeting their reserve requirements, depositors might have
to pay banks to provide safekeeping services for their money. For the economy and the banking
system as a whole, the practice of keeping only a fraction of deposits on hand has an important
cumulative effect. Referred to as the fractional reserve system, it permits the banking system to
create money.

How It Works

The nature of modern banking is such that the cash reserves at the bank available to repay
demand deposits need only be a fraction of the demand deposits owed to depositors. In most
legal systems, a demand deposit at a bank e.g. a checking or savings account is considered a loan
to the bank repayable on demand, that the bank can use to finance its investments in loans and
interest bearing securities. Banks make a profit based on the difference between the interest they
charge on the loans they make, and the interest they pay to their depositors. Since a bank lends
out most of the money deposited, keeping only a fraction of the total as reserves, it necessarily
has less money than the account balances of its depositors.

Money Creation

Modern central banking allows multiple banks to practice fractional reserve banking with
Inter bank business transactions without risking bankruptcy. The process of fractional- reserve
banking has a cumulative effect of money creation by banks, essentially expanding money
supply of the economy. There are two types of money in a fractional-reserve banking system
operating with a central bank
Central bank money: Money created or adopted by the central bank regardless of its form
Precious metals, commodity certificates, banknotes, coins, electronic money loaned to
commercial banks, or anything else the central bank chooses as its form of money
Commercial bank money: Demand deposits in the commercial banking system - sometimes
Referred to as cheque book money

Money Multiplier
The most common mechanism used to measure this increase in the money supply is typically
called the money multiplier. It calculates the maximum amount of money that an initial deposit
can be expanded to with a given reserve ratio.
Formula
The money multiplier, m, is the inverse of the reserve requirement, R

M=1/R
Example
For example, with the reserve ratio of 20 percent, this reserve ratio, R, can also be expressed as a
fraction:
R=1/5

So then the money multiplier, m, will be calculated as:

M=1/ 1/5 = 5

This number is multiplied by the initial deposit to show the maximum amount of money it can be
expanded to.

Reserve Requirements

The reserve requirements are intended to prevent banks from:

Generating too much money by making too many loans against the narrow money
deposit base.
Having a shortage of cash when large deposits are withdrawn although the reserve is a legal
minimum, it is understood that in a crisis or bank run and reserves may be made available on
a temporary basis.
THE MORAL HAZARD IMPLICATIONS OF DEPOSIT INSURANCE

Deposit insurance is a tightrope act. On the one hand, explicit deposit insurance can significantly
reduce the incidence of bank runs or even stop runs altogether in countries with strong
institutions and proper safeguards. On the other hand, when not done carefully, explicit deposit
insurance can fuel bank crises by giving banks perverse incentives to take unnecessary risks.1
The United States learned a painful lesson in this regard in the 1980s and early 1990s, when an
overly generous deposit insurance system helped trigger the largest wave of bank failures there
since the Great Depression in the 1930s.2 As the U.S. experience suggests, any country that
adopts explicit deposit insurance must grapple with the destabilizing effects of that insurance on
the country‟s financial system. This problem, known as “moral hazard,” has taken on new
significance with the rapid spread of explicit deposit insurance. Most countries are reluctant to
permit banks to go insolvent without providing relief to depositors and thus governments
commonly extend depositors some sort of financial safety net. Until the early 1990s, however,
this financial safety net did not include explicit deposit insurance in most countries. Instead, the
vast majority of nations relied on other types of safety nets, including implicit deposit
guarantees. A country signals implicit

The Prevalence of Deposit Insurance Worldwide

Today, deposit guarantees are the norm, not the exception, in banking systems around the world.
When it comes to depositor protection, nations essentially have six choices. First, they can enact
a law expressly denying deposit insurance protection, as New Zealand has done. Second, they
can expressly deny deposit insurance, but give priority to depositors over other claimants in
failed bank insolvency proceedings. This is the approach in Australia. Third, countries can be
ambiguous about implicit coverage (which is the default position if there is no law on point).
Fourth, countries can signal implicit deposit guarantees through their actions by consistently
bailing out failed banks and their depositors, as of 2003, 93 countries reported using this
approach. Fifth, nations can explicit deposit guarantees with coverage limits. By 2003, eighty-
eight countries had adopted this approach. Today, explicit deposit insurance is found
predominantly in Europe, Central Asia, Latin America, and the Caribbean, but relatively rarely
in sub-Saharan Africa. Finally, countries can opt for explicit deposit guarantees with full
coverage. This last approach occurs rarely and is usually reserved for severe systemic financial
crises. Sixth In 2003, only the Dominican Republic, Indonesia, Malaysia, Thailand, Turkey and
Turkmenistan had full explicit coverage There are several reasons for the recent widespread
adoption of explicit deposit insurance. Explicit guarantees have immense political appeal
because they assuage citizens‟ concerns about the safety of their deposits and thus increase the
flow of funds into banks without requiring fiscal expenditures.

Rationales for Deposit Insurance

As the preceding discussion suggests, explicit deposit guarantees are an increasingly common
response to the problem of bank runs and contagion. Banks are uniquely prone to runs because
they borrow “short” by taking in demand deposits and lend “long” by making loans with longer
maturities. This results in a “term mismatch” that makes the balance sheets of banks inherently
unstable when banks make loans. They assume the risk of holding illiquid assets fast enough to
satisfy depositors‟ demands and a bank run can ensue. Furthermore, bank runs can have a ripple
effect and trigger full-blown contagion. The unstable balance sheet of banks is not a quirk.
Rather, it is inherent to a key economic function of banks, which is providing financial liquidity.
As financial intermediaries, banks accept liquid deposits from the public and reinvest those funds
in long-term, illiquid loans. In the process, banks provide borrowers with liquidity by allowing
them to post their illiquid land or machinery as collateral and convert those assets into cash in the
form of loan proceeds.

The Moral Hazard Implications of Deposit Insurance

In the deposit insurance context, moral hazard manifests itself in two ways. First, explicit deposit
insurance gives insured banks incentives to pursue added risks because they can capture any
profits but shift any losses to the government. Second, explicit deposit insurance reduces
incentives by depositors and shareholders to monitor their banks. In a world with no deposit
insurance, a bank that is considering making a risky loan knows that it will have to pay
depositors more for taking on the added risk. Either the bank will pay the risk premium or it will
not make the loan. In a world with deposit insurance, however, insured depositors will not
demand a risk premium because they know that the government will insure their deposits up to
the legal limit, regardless whether the bank makes the loan. Thus, deposit insurance gives banks
incentives to take added risks – either by increasing their leverage or investing in riskier assets --
thereby increasing the government exposure to losses.
These incentives are especially strong for undercapitalized banks. Moral hazard will exist so long
as the total expected profits from a bank‟s asset portfolio exceed the explicit costs of deposit
insurance (premiums) plus its implicit costs (the costs of regulation). To appreciate the
magnitude of moral hazard in the banking sphere, one must keep in mind that in reality, deposit
insurance is not insurance at all, but a guaranty against loss. Normally, private insurance insures
only against losses due to defined risks (such as death due to illness or an accident, but not due to
suicide by the insured). Such exclusions give insured incentives to guard against preventable
losses.

Constraints on Moral Hazard

Despite the moral hazard in explicit deposit insurance, in many countries it is possible to institute
deposit guarantees consistent with financial stability, though not in all. Moral hazard is why
governments put elaborate banking regulation systems in place, replete with entry restrictions,
activity restrictions, prophylactic rules, examinations, and sanctions. Similarly, tough bank
resolution techniques, including prompt closure of critically undercapitalized banks and
prohibitions against bailouts of failed bank shareholders, are crucial safeguards against moral
hazard. These measures are not enough alone to curb moral hazard. In addition, three more
things are needed to reduce the risk created by deposit insurance. First, all deposit insurance
schemes need to incorporate risk-reducing features. Second, and related to the first, countries
need to foster incentives to encourage large depositors, shareholders, and other creditors to
monitor their banks. Finally, neither of these points matters if a country lacks the institutions to
adopt and enforces these safeguards. Unless countries have strong institutional environments,
explicit deposit insurance will do more harm than good to their overall financial stability.

 Designing Explicit Deposit Insurance

In systems where explicit deposit insurance is appropriate – that is, in countries with strong
institutional safeguards against moral hazard – strict banking regulation is not enough alone to
constrain risk. Research has found that explicit deposit insurance removes more restraints on risk
than government regulators are able to furnish. Accordingly, explicit deposit insurance must
specifically be designed with risk-reduction features in mind.

 Coverage Limits

Coverage limits are a common technique used by private insurers to control risk. In explicit
deposit insurance schemes, coverage limits usually take three forms. First, coverage limits
address what types of institutions the deposit guarantees cover. Some systems only seek to cover
the payment system and thus limit coverage to commercial banks; other systems cover savings
institutions too. Second, coverage limits address what types of deposits are covered. Some
systems, for example, extend coverage to foreign currency deposits; other systems do not. Most
systems exclude foreign deposits of domestic banks and domestic deposits of foreign banks. In
rare instances, some deposit insurance systems also cover interbank deposits.

 Market Discipline

In recent years, policymakers have paid increased attention to ways to exert market discipline on
banks, other than bank runs. Market discipline can take many forms, including private
monitoring by interested stakeholders, corporate governance, and ousters of bank managers
through the market for corporate control. Large depositors, shareholders, and other unsecured
creditors all play an important role in monitoring banks. For example, explicit deposit insurance
can and should be designed to encourage large depositors to oversee their banks. Coverage limits
and coinsurance help accomplish this by placing deposits over the coverage limits at risk of loss.

Conclusion

This tells us that, Countries considering explicit deposit insurance should watch out for what
they wish for. Unless a country has strong banking regulation, a strict failed bank resolution
regime, carefully designed deposit insurance with safeguards against risk, healthy private
monitoring, and, most of all, strong institutions, explicit deposit insurance will only be a recipe
for future bank crises. Conversely, if all five of these safeguards are in place, explicit deposit
insurance can protect depositors while holding moral hazard in check.
NEED FOR CONSUMER CREDIT AND ITS IMPACT ON ECONOMY

Consumer Credit Control

The so-called consumer credit control refers to the central bank's purchase of consumer durables
and consumer loans phases of the management measures aimed at influencing consumers to pay
for consumer durables capacity requirements. in demand and inflation, the central bank can take
some credit to consumers the necessary management measures, such as the provision of various
consumer durables are paid the minimum amount, and for the purchase of these products
provides maximum duration of the loan, society for the purchase of durable goods reduced
spending, and ease-expansion pressure. On the contrary, in times of economic recession must be
lifted or relaxed restrictions on consumer credit conditions to increase the purchasing power of
consumer‟s goods, promote economic recovery. Such measures can be effective in controlling
the growth of consumer credit. At present, as the development of consumer credit, such selective
monetary instruments through a wide range of consumer credit participants, conduction effect
can be improved, in particular to expanding the role of the central bank's monetary policy based
on face ultimately contribute to the central bank through selective currency policy implications
of a particular market. Specifically, in the area of consumer credit, through adjustment loan
interest rates and down payment ratio of total borrowings → affected residents → regulate social
credit total → total consumption → affect social role in the national economy and the overall
supply and demand balance. Secondly, to adjust the different types of consumer credit loans or
down payment on the interest rate adjustment of monetary and credit → proportion of the use of
structural adjustment → social consumption structure.

Consumer Credit control of the main content

Its main contents include:

Provides hire purchase of all types of consumer credit, such as consumer durables, the
first payment of the minimum amount;

Prescribes the use of hire purchase of all types of consumer credit and other consumer
durable goods, the longest period of the borrower;

Prescribes the use of consumer installment credit to buy consumer durables categories,
and provides for the purchase of consumer durables can hire;
 Other consumer installment credit to purchase consumer durable goods, consumer
durables on the different requirements for different lenders.

The Effect of Consumer Credit Control

This tool is the use of the Central Bank to regulate consumer credit and adjustment. Because
consumer credit is an important form of credit, and its huge volume and closely linked with the
general public, if left unchecked, will often interfere with economic stability. Central bank
consumer credit control is the objective demand of economic operation, the appropriate use of
time it can inhibit the excessive use of consumer credit and inflation, the economy's stability and
development and to reduce the economic cycle plays an important role in the shock.
ROLE OF CENTRAL BANK IN CREDIT CONTROL

Section I The so-called First, credit management, credit transactions scientific management to
control credit risk expertise. Credit Management's main features include five areas: management
of credit, credit management, the control and management of accounts, to recover the account
management, use of credit information database market development or marketing of credit
payment instruments.
Second, credit management and credit risk Credit management must be mentioned that credit
risk, credit management in order to understand the purpose and functions, and the resulting
extended to the management techniques and methods. Credit risk is a risk. It refers specifically to
transactions in the credit risk, that is, the risk of non-payment due. The credit risk caused by
many factors, including political risk, information risk, business risk, risk management, financial
risk, and so on.
Third, credit management functions and target market Credit management is the provision of
credit management side of the method to solve the credit risk of transactions in question. The
main functions of credit management, including risk identification, risk assessment, risk analysis,
and based on this, the effective risk control, and with the economy, reasonable approach to deal
with comprehensive risk.
In the real market environment, as the main credit transactions and the different forms of credit
management objectives for the market is divided into three segments: capital, businesses and
individual consumers. In the different target market, the characteristics of different credit risks,
credit management functions and have different content.
Section II individual consumer credit management First, the individual consumer credit
management outlined
First, concept, function and classification Consumer Credit Management is scientific
management expertise, and expand consumer credit, credit risk prevention technological means.
The main consumer credit management functions: customer credit investigations, customer
credit, account control, to account collection and the use of personal credit information database
marketing credit payment instruments. In different forms of personal credit sales, risk factors
also varied. Different forms of credit transactions, credit repayment, as well as payment of the
different main consumer credit can be divided into retail credit, cash credit, and real estate credit.
The retail credit also can be divided into revolving credit, installment credit and credit services.
Second, the characteristics of consumer credit management Consumer Credit Management
and Enterprise Credit Management and commercial banks in credit management and customer
service approach has notable difference between these differences in their decision to credit
management techniques and the different means. Consumer Credit management objectives for
individual customers are consumers, and the corporate credit management and commercial bank
credit management objectives for corporate enterprise customers. The characteristics of
individual credit consumption are the amount of small single transaction, but the large number of
transactions. In addition personal consumer credit transactions in a very flexible way to deal with
transaction records and credit record settlement of the enormous amount of data. Second,
consumer credit management functions in the enterprise consumer credit management in the
enterprise functions are mainly in the following aspects:

(a) Improve our credit review the efficiency and reduce the operating costs
(b) Reducing the risk of credit transactions, reduce arrears and timely recovery of arrears
(c) Qualified for enterprises to increase the users, reducing the ratio of bad customers
(d) From the perspective of risk control, product innovation to assist enterprises

Third, consumer credit management workflow Credit management process and is closely
related to the process of marketing. To a credit transaction for the entire process unit, consumer
credit management by the customer credit, account management, commercial accounts, such as
reminders lost several components.

I. Customers credit when consumer credit applications, the enterprises credit management
departments should first examine its credit, and any business credit standards, the final decision
whether or not to grant credit, the number of lines. Credit standards are the internal corporate
documents, it provides for reunification under a variety of circumstances and conditions in credit
standards. Enterprise credit management departments based on this standard, consumer credit
applications to express their views, that is, whether credit, the number of lines, number of
deadlines.

II. Account management consumer acceptance of credit trading conditions, the corporate credit
management departments to open a credit account, record all transaction data, repayment records
and credit records. Risk of default due to the existence of corporate credit management
departments of the credit period to consumers the amount of risk monitoring and adjustment, but
also assist the sales department to find new trading opportunities.
III. To account processing account to be handled in two parts: First, the normal accounts
payable recovery, that is, to provide consumers with regular bills to remind consumers to the
timely repayment of loans; Second, the collection of accounts in arrears.
INFLATION

Inflation is a key indicator of a country and provides important insight on the state of the
economy and the sound macroeconomic policies that govern it. A stable inflation not only gives
a nurturing environment for economic growth, but also uplifts the poor and fixed income citizens
who are the most vulnerable in society. Over the last decade, with a few exceptions, inflation
around the world had been at a retreat. However, with buoyant global growth, along with higher
population growth, rapid industrialization and urbanization in emerging markets, and strong per
capita income growth, inflation has started veering its ugly head in many parts of the world,
including Pakistan. In the midst of soaring demand for essential commodities, food inflation has
emerged as the main contributor to recent global inflationary pressures. There is a general
consensus that the era of cheap food is over. Soaring food prices over the last year have helped
propel inflation all around the world, sparking protests and even riots in some countries. The
high price of food in the global arena as well as short-sighted policy responses threatens to push
millions into poverty. Rising food prices have pushed up overall inflation not only in Pakistan,
but across the region, particularly during 2007 and mid-2008. This is worrisome given that food
price inflation is the most regressive of all taxes, hurting the poor and fixed income groups the
most. Additionally, this explosion in international food prices is a threat to macroeconomic
stability through inflation, the rising fiscal cost of food subsidies, and the negative impact on the
exchange rate for net food/energy importing countries like Pakistan.

For a developing country like Pakistan, inflation needs to be stabilized in order to ensure
sustainable growth as well as macroeconomic stability. Both empirical and theoretical studies
demonstrate that there is a strong link between inflation and output (unemployment). Very high
levels of inflation as well as very low levels of inflation are equally damaging for an economy.
Both extremes arrest growth prospects, impose economic suffering on the population, because
inefficient allocation of resources inexplicably hurt the poor and fixed income groups, create
uncertainty throughout the economy and undermine macroeconomic policies. High inflation
always burdens the poor and fixed income groups more than the rich since they are not able to
protect themselves against the costs attached to inflation, nor able to hedge against the risks that
inflation brings with it. In contrast, low or falling inflation can also have a negative impact on
growth through several different factors. For instance, falling asset prices can constrain
collateralized lending; the negative wealth effect can slow down demand; and borrowers are
worse off since the real rates have turned against them. The Government needs to be cautious
about inflation and thus has taken various steps to release demand pressures on the one hand and
enhance supplies of essential commodities on the other. To ease demand pressures, the State
Bank of Pakistan (SBP) has continuously tightened the monetary policy over the last three years
and more so in the current fiscal year, while to enhance supplies, the Government has relaxed its
import regime and allowed imports of several essential items so that there is a continu ous flow in
the supply of those important commodities. In addition, the Government increased the imports of
items like wheat, pulses and sugar to complement the efforts of the private sector. In order to
provide relief to the common man, the government also increased the scale of operations of the
Utility Stores Corporation (USC) which supplies essential commodities such as wheat flour,
sugar, pulses and cooking oil/ ghee at less than the market prices.
TRADE DEFICIT

Salient Features of the Monetary Policy

State Bank of Pakistan was established with two broad objectives; to secure monetary stability
and to find fuller utilization of country‟s productive resources. These objectives are confined
under the head of‟ Functions and Responsibilities of the Central Board‟ by making it responsible
to secure monetary stability and soundness of the financial system. The Act 1956 of the State
Bank of Pakistan (amended) states that „the target rates of growth and inflation set by the Federal
Government are the targets of monetary policy‟. Therefore target rate of inflation is the prime
objective of monetary policy in Pakistan. Monetary policy management is one of the primary
goals of the State Bank of Pakistan (SBP).

In Pakistan the monetary policy has been supportive of the dual objectives, promoting economic
growth and price stability. However, during the period from 2001 to 2005 monetary policy in
Pakistan was biased towards supporting growth because of expectations that inflation could be
maintained at low levels while giving the economy a monetary stimulus. Inflation started
accelerating in 2005 that forced a reversal of monetary policy. The SBP is claiming to maintain
tight monetary policy to deal with inflation particularly core inflation since September 2004.
Further it is claimed that monetary policy has had a visible impact on core inflation during FY06
and FY07. However, at the end of financial year 2007 core inflation started increasing. The
stated reason is reserve money growth and supply management problem. It is observed that the
tight monetary policy stance has begun to lose some of its steam as manifested by a moderate
increase in KIBOR and banks‟ lending rates, almost flat Monetary Conditions Index (MCI), a
fall in the effective CRR, and persistently high annualized M2 growth rate. First we discuss the
situation of state of inflation, which is prime objective of monetary policy in Pakistan, during the
period from 1991 to 2008. The target and actual rate of inflation is given in Table 1 and
percentage deviation of actual rate of inflation from the targeted rate of inflation is presented in
the Figure 1.

As can be seen from the table, from 1991 to 1997 the actual rate of inflation remained above the
target level. After 1997 till 2003 the actual rate of Inflation in Pakistan remained below the target
level implies it was under the control of authorities. It started rising from 2004 and remained
above the target level except one year that is 2006 when it was exactly equal to the target rate. At
the end of the financial year 2007-08 actual inflation substantially 100% higher surpassed the
target level of inflation set by the federal government. In order to achieve the objectives of
monetary policy the SBP targets monetary aggregate (M2) in accordance with the targets of real.
GDP growth and inflation set by the Government.

Trade Structure and Policies in Pakistan

Pakistan inherited a weak industrial base since its inception as an independent state. In order to
increase the industrial units, the government initially adopted the Import Substitution
Industrialization (ISI) strategy. The main objective of this policy was to replace the domestic
demand for imported consumer goods by domestically produced goods with more emphasis on
encouraging the import of capital goods and raw material by relaxing restrictions.4 In this
context, the important measures which were taken to liberalize imports of raw material were: (I)
introduction of Free List for raw material imports; (ii) expanding licensable imports list; and (iii)
simplification in procedures of import licensing. As a result of these policies, the share of
consumer goods in total imports reduced from 30 percent in 1960-61 to 16 percent in 1969-70.
While the share of capital and intermediate goods in total imports increased from 71 percent to
84 percent during the same period.On the other hand, in order to encourage exports, the
government introduced the Export Bonus scheme (EBS) in the first half of the 60s, with an aim
to support the exporters of manufactured goods through more favorable exchange rates.
Similarly, the government maintained its policy stance for the promotion of export in later half of
the decade in the form of issuance of Export Performance License during 1968. During the
decade of the 1970s, trade policy continued towards import liberalization and export promotion.
The main focus of the import policy was to eliminate administrative controls which adversely
affect exports. In this context, the distinctions between industrial and commercial importers were
removed, import of capital goods under Free List was permitted, and extensions were made in
the Free List of raw material. On the export side, the Export Refinance Scheme (ERS) was
introduced by the State Bank of Pakistan, adjustments were made in export duties on a number
of items, tax exemption and rebate on excise and custom duties were also allowed to exporters.7
In addition, after the devaluation of Pak Rupee by 10 percent in 1973, the exchange rate was
pegged with the dollar at Rs 9.90/$.

It is important to note, that besides the incentives provided by the government, there were some
exogenous factors that adversely affected the export growth during the same period. Specifically,
there was an increase in international oil price which led to recession in the international market
and erratic agricultural performance of the country. Thus, exports decreased to an average of 7.0
percent of GDP in 1976-80 from an average of 8.1 percent of GDP during 1972-75. While,
imports to GDP ratio increased to an average of 14.1 percent from an average of 10.9 percent of
GDP in the same period.

Warren Buffet on Trade Deficits

The successful American businessman and investor Warren Buffet was quoted in the associated
press (January 20, 2006) as saying, “The U.S. trade deficit is a bigger threat to the domestic
economy than either the federal budget deficit or consumer debt and could lead to political
turmoil…..Right now, the rest of world owns $3 trillion more of us than we own of them.”

Physical Balance Of Trade

Monetary balance of trade is different from physical balance of trade (which is expressed in
amount of raw materials). Developed countries usually import a lot of primary raw materials
from developing countries at low prices. Often, these materials are then converted into finished
products, and a significant amount of value is added. Although for instance the EU (as well as
many other developed countries) has a balanced monetary balance of trade, its physical trade
balance (especially with developing countries) is negative, meaning that a lot less material is
exported than imported.

NATIONAL RESERVES UTILIZATION FOR DEVELOPMENT PLAN

National Social Development Research Program

First. Basic Nature and Pur-Poses

The National Development Research Program was formulated in 1995 in order to implement the
strategy "Promote the development of the country with science and education" and the strategy
of sustainable development. This program is a program of activities in the implementation of the
Chinese strategy of sustainable development and a national scientific and technological research
on social development. The work of scientific and technological research on social development
is of scientific and technological activities aimed at promoting the life quality of people and the
quality of people themselves, improving the environment for people's survival and development,
adjusting the relations between people and the nature, promoting the scientific and technological
progress of social undertakings and related industries, and promote the coordination between of
economy and society and the sustainable development.
This program is a rolling program, mainly a guidance program in nature, for scientific and
technological development and is planned to be implemented in the period form 1996 to 2010

Second. The Main Objectives

This program is for the purpose of improving the social environment and supporting conditions
for the national economic development, promoting the quality of population and the quality of
the people's life, and promoting the coordinated, sustainable development of economy and
society.
I. Energetically Promote Technical Innovation and Integration of Science and Technology
with Economy

Extend a large batch of scientific and technological achievements in the field of social
development and form a large number of science and technology guided industries, The
implementation of this program should greatly contribute to the promotion of the integrated
should greatly contribute to the promotion of the integrated national power and create the
necessary material basis for the promotion of quality of the people's livelihood and satisfaction
of increasing material and cultural needs of the people.

II. Deepen institutional Reform of Research Institutes Related with Social Development

Establish step by step a research team of small number of members but high quality; establish a
batch of research centers of engineering and technologies; and establish several bases of research
and development and demonstrative projects.

III. Continue to Develop a Batch of Comprehensive Experimental Zones for Science and
Technology Guiding Social Development

The construction of comprehensive experimental zones for social development is an important

instrument for promoting the implementation of the China Agenda 21, and the number of the
zones will increase by about 60 in the Ninth Five-year Plan period so as to further promote the
urban and rural sustainable development.

IV. Strengthen Basic Research Work and the Fostering of Leading Scientists to Work into
the Next Century

In the field of basic research work, during the Ninth Five-year Plan period, it is important to well
understand the conditions of China, establish resource data bases with modern information
technologies and instruments for the fields of national land, mineral resources, seas and oceans,
hazards, urbanization, etc. and realize data sharing; foster and select a batch of leading scientists
to work into the next century and a batch of scientific and technological type entrepreneurs.

Third. The Main Contents

During the Ninth Five-year Plan period, the following four aspects will be taken as the key fields
of activities
I. Emphatically Arrange the Scientific and Technological Work in the Fields of Development of
Initiative Medicines, Population Control and Health, Residence Construction, Hazards Reduction
and Control in Order to Promote the Quality of the People‟s Livelihood. The 1035Plan for
Initiative Medicine Technologies before year 2000, develop ten patented class an initiative
medicines and a batch of urgently needed therapeutic medicines, new preparations and new
varieties of medicines, make breakthroughs in a batch of key technologies for medicine
manufacturing. At the same time, establish five medicine screening centers, five medicine safety
evaluation centers (GLP) and five medicine clinical research centers (GCP), form relatively an
intact system for new medicine research and development, promote China's capacity of new
medicine development and level of intellectual property rights and alleviate the challenge of
intellectual property rights and alleviate the big problem of medicine supply for the 1.2billion
Chinese people science and technology for population control and health Develop safety
effective, simple and economical new technologies for birth adjustment to meet the social needs.
During the Ninth Five-year, aimed at the change of disease spectrum and new problems crested
in the population aging, emphatically develop contraceptive vaccine, new technologies and
methods for the control of malignant tumor, cardiovascular diseases, geriatric diseases, etc, and
related new type medical apparatus and instruments and medical materials.

II. Emphatically Develop the Technologies for Water Resources Development, Water Resources
Development, Water Treatment, Smoke Desulphurization, Resource Circulation, Resource
Circulation, Reclamation and Comprehensive Use. Comprehensive technologies and industries
to alleviate fresh water crisis strengthen the study of utilization and protection of water resources
and integrated technologies for the control of water pollution, emphatically develop technologies
for clean production of water consuming industries, develop key technologies and equipments
for control of waste water pollution of typical industries and desalinization and direct use of sea
water, study technologies for optimized allocation of water, study technologies for optimized
allocation of water resources and purification of special water bodies, promote industrialization
of water saving, waste water control and sea water desalinization new technologies of clean coal.
Take the control of sulfur dioxide in the smoke from coal burning equipments as the objective
and develop several new technologies for the reduction of discharge of discharge of pollutants
from coal burning, which are oriented to the 21st century, have wide prospects of application and
are fit for the conditions of China, by fully using advanced technical achievements in related
fields and combining imported technologies with those self-developed.

Fourth. The Main Support Conditions and Measures

I. Give Full Play to and Further Trans form Governmental Functions

 For the social public good and welfare facilities or services dominated by social benefits,
mainly rely on governmental support, continuously improve the social organization and
 management; for the social facilities or services with economic benefits or potential of
economic benefits, take science and technology as the guidance, promote the industries of
science and technology to develop and get onto the track of self-accumulation and self-
development.

 Strengthen the coordination and cooperation between different departments and sectors to
form a plan management system involving the levels of the state, departments, localities
and enterprises, with mutual contact between levels and each with particular emphasis so
as to better manage scientific and technological resources and solve vital problems in the
social development.

II. Create Sound Environment for Technical Innovation and Promote the Transformation
of Scientific and Promote the Transformation of Scientific and Technological Achievements

 Strengthen links in the whole process of technical innovation, strengthen interim

experiment and technical transfer and construct a batch of comprehensive demonstrative
pilot projects and product and industrial bases for the science and technology of social
development.

 Take the whole process of key projects as the core and establish dynamic scientific and
technological information and project banks.

III. Give Full Play to the Potential Superiority of Large and Medium Enterprises and
Military Enterprises and Make Use of the Flexible Mechanism of Township Enterprises to
Accelerate the Development of Related Enterprises of Social Development

IV. Establish the Fund Raising and Investment Mechanism of Multiple Approaches and
Multiple Levels while striving for Steadily Increasing Government Funding.

 Strengthen the combination of science and technology with banking agencies, and
establish working groups with representatives from banding agencies for important
projects.

Create conditions and start with funds rising for projects in order to establish the
science and technology foundation at a proper time for sustainable development.


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reserve_banking , http://www.lewrockwell.com/rothbard/frb.html

McCoy.P.A. (2007, February). The Moral Hazard Implications of Deposit Insurance theory and evidence.
Current development in monetary and financial law. Washington. D.C. October 23-27, 2006 Retrieved
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uwi.org/files/publications/seminar/hferhani05.pdf

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