The State Bank of Pakistan (SBP) is the central bank of Pakistan and is charged with the duty to "regulate the issue of bank notes and keeping of reserves with a view to securing monetary stability in Pakistan and generally to operate the currency and credit system of the country to its advantage".

1. PROJECT ON
BANKING LAW
Submitted To:
MISS. UZMA
Project On:
BUDGET AND MONETARY POLICY
OF STATE BANK OF PAKISTAN
Submitted By:
SALMA BASHIR 126
SANA KHALID 127
NASIBA WARIS 139
SAMEERA 1542
SOBIA IKHLAQ 1548
KIRAN ZAHRA 1550
SABA KHURSHED 1541
Section: “C” (Morning)
Semester 6th

2. State Bank of
Pakistan
State Bank of Pakistan
‫ﻦﺎﺘﺴﻜﺎﭘ ﺖﻠﻮﺪ ﮎﻨﻴﺑ‬
The State Bank of Pakistan (SBP) is the central bank of Pakistan. While its constitution,
as originally laid down in the State Bank of Pakistan Order 1948, remained basically
unchanged until January 1,1974, when the bank was nationalized, the scope of its functions
was considerably enlarged. The State Bank of Pakistan Act 1956, with subsequent
amendments, forms the basis of its operations today. The headquarters are located in the
financial capital of Pakistan, Karachi with its second headquarters in the capital, Islamabad.
History
Before independence on 14 August 1947, the Reserve Bank of India (central bank of India)
was the central bank for what is now Pakistan. On 30 December 1948 the British
Government's commission distributed the Bank of India's reserves between Pakistan and
India - 30 percent (750 M gold) for Pakistan and 70 percent for India.
The losses incurred in the transition to independence were taken from Pakistan's share (a
total of 230 million). In May, 1948 Muhammad Ali Jinnah (Founder of Pakistan) took steps
to establish the State Bank of Pakistan immediately. These were implemented in June
1948, and the State Bank of Pakistan commenced operation on July 1, 1948

3. Facts and Figures:
Headquarters Karachi, Pakistan
Established 1947
Governor Shamshad Akhtar
Central Bank of Pakistan
Currency Pakistani rupee
ISO 4217 Code PKR
Official Website www.spb.org.pk
Departments
Agricultural Credit
•
Audit
•
Banking Inspection
•
Banking Policy
•
Banking Supervision
•
Corporate Services
•
Economic Policy
•
Exchange and Debt Management
•
Exchange Policy
•
Human Resource
•
Information System
•
Islamic Banking
•
Legal Services
•
Payment System
•
Research
•
Statistics
•
Real Time Gross Settlement System (RTGS System)
•
Small and Medium Enterprises
•
Training and Development Department (TDD)
•
MEMBERS
Central Board of s Chairperson
1.
2. The Secretary Finance Member
3. Mr. Khair Mohamed Junejo Member
4. Mr. Ehsen Rashid
5. Mr. M. Yaqoob Vardag Member
6. Mr. Mohsin Aziz Member

4. 7. Dr. Wasim Azhar Member
8. Mr. Kamran Y. Mirza Member
9. Mr. Alman A. Aslam Member
10. Mr. Riaz Ahmed Secretary
Functions
Under the State Bank of Pakistan Order 1948, the state bank of Pakistan was charged with
the duty to quot;regulate the issue of bank notes and keeping of reserves with a view to
securing monetary stability in Pakistan and generally to operate the currency and credit
system of the country to its advantagequot;.
A large section of the state bank's duties were widened when the State Bank of Pakistan
Act 1956 was introduced. It required the state bank to quot;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 country’s productive resourcesquot;. In
February 1994, the State Bank was given full autonomy, during the financial sector
reforms.
On January 21, 1997, this autonomy was further strengthened when the government issued
three Amendment Ordinances (which were approved by the Parliament in May 1997).
Those included were the State Bank of Pakistan Act, 1956, Banking Companies Ordinance,
1962 and Banks Nationalization Act, 1974. These changes gave full and exclusive
authority to the State Bank to regulate the banking sector, to conduct an independent
monetary policy and to set limit on government borrowings from the State Bank of
Pakistan.
The State Bank of Pakistan also performs both the traditional and developmental functions
to achieve macroeconomic goals. The traditional functions may be classified into two
groups:
1. 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.
2. 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.
Regulation of liquidity
The State Bank of Pakistan has also been entrusted with the responsibility to carry out
monetary and credit policy in accordance with Government targets for growth and inflation
with the recommendations of the Monetary and Fiscal Policies Co-ordination Board
without trying to effect the macroeconomic policy objectives.

5. The state bank also regulates the volume and the direction of flow of credit to different uses
and sectors, the state bank makes use of both direct and indirect instruments of monetary
management. During the 1980s, Pakistan embarked upon a program of financial sector
reforms, which lead to a number of fundamental changes. Due to these changed the
conduct of monetary management which brought about changes to the administrative
controls and quantitative restrictions to market based monetary management. A reserve
money management programme has been developed, for intermediate target of M2, which
would be achieved by observing the desired path of reserve money - the operating target.
ENSURING THE SOUNDNESS OF FINANCIAL SYSTEM:
REGULATION AND SUPERVISION:
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.
The quot;Prudential Regulationsquot; for banks, besides providing for credit and risk exposure
limits, prescribe guide lines relating to classification of short-term and long-term loan
facilities, set criteria for management, prohibit criminal use of banking channels for the
purpose of money laundering and other unlawful activities, lay down rules for the payment
of dividends, direct banks to refrain from window dressing and prohibit them to extend
fresh loan to defaulters of old loans. The existing format of balance sheet and profit-and-
loss account has been changed to conform to international standards, ensuring adequate
transparency of operations. Revised capital requirements, envisaging minimum paid up
capital of Rs.500 million have been enforced. Effective December, 1997, every bank was
required to maintain capital and unencumbered general reserves equivalent to 8 per cent of
its risk weighted assets.
The quot;Rules of Businessquot; for NBFIs became effective since the day NBFIs came under State
Bank’s jurisdiction. As from January, 1997, modarbas and leasing companies, which is also
specialized type of NBFIs, are being regulated /supervised by the Securities and Exchange
Commission (SECP), rather than the State Bank of Pakistan?

6. DEVELOPMENTAL ROLE OF STATE BANK
The responsibility of a Central Bank in a developing country goes well beyond the
regulatory duties of managing the monetary policy in order to achieve the macro-economic
goals. This role covers not only the development of important components of monetary and
capital markets but also to assist the process of economic growth and promote the fuller
utilization of a country’s resources.
Ever since its establishment, the State Bank of Pakistan, besides discharging its traditional
functions of regulating money and credit, has played an active developmental role to
promote the realization of macro-economic goals. The explicit recognition of the
promotional role of the Central Bank evidently stems from a desire to re-orientate all
policies towards the goal of rapid economic growth. Accordingly, the orthodox central
banking functions have been combined by the State Bank with a well-recognized
developmental role.
The scope of Bank’s operations has been widened considerably by including the economic
growth objective in its statute under the State Bank of Pakistan Act 1956. The Bank’s
participation in the development process has been in the form of rehabilitation of banking
system in Pakistan, development of new financial institutions and debt instruments in order
to promote financial intermediation, establishment of Development Financial Institutions
(DFIs), directing the use of credit according to selected development priorities, providing
subsidized credit, and development of the capital market.
Introduction to budget
“An estimate, often itemized, of expected income and expense for a given period in the
future”.
“A plan of operations based on such an estimate”
“An itemized allotment of funds, time, etc., for a given period”.
Forecast of governmental expenditures and revenues for the ensuing fiscal year. In modern
industrial economies, the budget is the key instrument for the execution of government
economic policies. Because government budgets may promote or retard economic growth
in certain areas of the economy and because views about priorities in government spending
differ widely, government budgets are the focus of competing political interests.
Factor effect the budget
Inflation and Interest Rates
Discover how inflation works and the affect it can have on the market. Also, learn about
interest rates, what causes them to rise or drop, and why you should care.

7. Introduction to the Economy
Learn how the economy can be influenced by the US government through fiscal and
monetary policy. Understand the importance of a global economy and why individuals
should make a portion of their investments overseas.
Federal Reserve and Monetary Policy
Learn the basics about the Federal Reserve, The Federal Open Market Committee (FOMC),
and how monetary policy is used to target interest rates to avoid inflation and slow
economic growth.
SALIENT FEATURES
CUSTOMS BUDGETARY MEASURES 2007-08
Policy Objectives:
• Consistency and transparency in tariff policy.
• Minimizing the cost of doing business.
• Tariff reforms continued.
• Cascading principle in tariff rates maintained as guiding principle (primary raw
• materials @ 0%-5%, secondary/components @ 5-10% and finished goods @ 20-
• 25%).
• Industrial incentives for growth and expansion.
• Tariff classification scheme aligned with HS 2007 version.
• Amendments in SROs to align them with HS 2007 version.
• Amendments in Customs Act, Rules and Procedures for further simplification.
Structural measures:
• Adoption of Harmonized Commodity Description and Coding System - 2007
• Version. Necessary additions/deletions and amendments made in Pakistan
• Customs Tariff.
• Introduction of 0% duty slab in Tariff. The SRO regime squeezed in size.
Sect oral industrial incentives:
• In order to enhance local industrialization, capacity building, production
competitiveness efficiency and product present ability, duty rates on raw materials,
parts and components for manufacturing of the following items/products have
either been reduced or eliminated:

8.  CNG compressors.
 Paper and paperboard.
 Items/equipments which have dedicated use in non-conventional/
 Alternate renewable energy resources like solar, wind and bio tech.
 Gum base.
 Transformers, submersible motors, electricity meters, switchgears and
 electric bulbs and tube lights.
 Light engineering products.
 Polystyrenes and their raw materials.
 Energy saving lamps and its raw materials/ parts.
 Petroleum bitumen/ asphalt.
 Footwear.
 Football bladder.
 Aviation equipments.
• New sectors/sub-sectors have been added under the incentive regime for local
manufacturing. Existing exemption regime available to different industrial
segments has been deepened.
• Reduction/elimination of duty for introduction of Second Generation Tariff Policy
Reforms for:
 Gems & Jewelry
 Furniture
 Marble & Granite
 Horticulture
 Surgical equipment/medical devices.
Poultry feed items, poultry vitamins, evaporation air coolers, insulated
sandwich panels and silos for storage of poultry have been exempted from
duty.
Increase in duty rates:
In order to safeguard the local industry from an onslaught of foreign goods duty rates have
been increased on import of poultry meat, welded stainless steel pipes etc. Duty rates on
vehicles have been increased around the effective rate of CVT which has been merged in
customs duty. For up to 800cc cars there was no CVT, therefore rate of duty against these
vehicles has not been changed.
Revenue measures:
• Levy of 1% Special surcharge on imports excluding vegetables/pulses, edible
oil/ghee, crude petroleum, furnace oil, HSD, medicines, fertilizers, imports under
chapter 99, temporary imports etc.

9. • Merger of Capital Value Tax (CVT) in Customs duty.
• Levy of regulatory duty on export of specified metals and articles thereof.
Relief measures:
• Amnesty scheme for condo nation of delays in submission of installation/
consumption certificates etc.
• Amnesty from payment of fine/penalties and surcharges on payment of principal
amount.
Other measures:
• Downward revision of 5 yrs. capping to 3 yrs. for import of old/used cars/jeeps.
 5 yrs. tariff plan for auto sector.
 Reduction/elimination of duty rates on specified diesel generating sets.
 Inputs used by the newspaper industry are being provided at concessionary
 rate.
• Duty rates on equipments for broadcasting sector have been reduced to 5%.
• Extension of incentives for expansion and up-gradation of existing hospitals.
• Inclusion of PSF in DTRE scheme, payment of duty drawback and R&D Support
.
Legal changes:
• Legislative changes have been suggested for simplification of law/ procedures.
• Section 25 and 25A of the Customs Act have been amended to address the
phenomenon of under invoicing.
BRIEF POINTS ON INDIVIDUAL BUDGETARY
MEASURES:
RELIEF MEASURES
• Zero-rating of sales tax on sewing machines and bicycles.
 Zero-rating of sales tax on sewing machines and bicycles is aimed at
providing relief to the general public.
Exemption of sales tax on cottonseed oil:
• Cottonseed oil is the only locally produced vegetable oil subject to sales tax. To bring it at
par with other local vegetable oils and to provide relief to the oil mills, sales tax on
cottonseed oil has been exempted.

10. Sales tax zero-rating on writing inks and exercise books:
• To promote education and to make available essential educational items at reduced cost,
sales tax on writing ink and exercise books has been zero-rated.
Amnesty scheme for waiver of default surcharge and penalty.
• To encourage the taxpayers to clear their outstanding tax liabilities and to reduce the legal
disputes, amnesty of default surcharge and penalties has been announced. Taxpayers who
wish to avail the amnesty may deposit the principal amount of tax by 30.06.2007.
Abolition of excise duty on motor gasoline and jet fuel.
• In order to rationalize the taxation on POL products, excise duty @ Rs. 88/- paisa’s per
liter on motor gasoline and Rs. 6/- paisas per litre on jet fuel has been abolished. The
products remain chargeable to sales tax.
Abolition of excise duty on petroleum bitumen.
• To fulfill the increasing demand of bitumen in the country due to extensive roads
construction, it is important to make the imported bitumen compatible with locally
produced bitumen. Therefore, excise duty @ Rs. 2000/- PMT on bitumen has been
abolished. Customs duty is also being revised downwards
.
Zero-rating of sales tax on trailers and semi-trailers.
• To promote the domestic production of better trailers and semi-trailers for the
improvement of goods transport, it is proposed to zero-rate sales tax on trailers and semi-
trailers.
Abolition of excise duty on exchange companies and health insurance.
• To promote the flow of remittances through official channels, excise duty @ 5% on
exchange companies has been abolished. Moreover, to provide level playing field to non-
life insurance companies in the field of health insurance vis-à-vis life insurance companies,
excise duty leviable @ 5% on health insurance has been abolished.
Exemption of sales tax arrears of industries located in FATA/PATA.
• The industries located in FATA/PATA are closed because of sales tax arrears created as a
result of the relief provided to the industries by Peshawar High Court which was later on
decided against by the Supreme Court. To provide relief to the industries in FATA/PATA,
it is proposed to exempt the arrears of sales tax against the units subject to the condition
that disputed excise duty and customs duty is duly deposited by them.
t Zero-rating of utilities of rice exporters.

11. • Local supply of rice is exempt being agricultural produce. Exports are also zero-rated but
the exporters have to obtain refund of small incidental e.g. sales tax on utility bills. To
boost the industry, it is proposed to zero-rate the utility of rice exporters.
b Exemption of sales tax on glass bangles.
• To provide relief to the traditional bangle industry of Sindh, glass bangles have been
exempted from sales tax.
Abolition of excise duty on cable TV operators.
• To boost the media industry and to provide cheaper entertainment to the general public,
excise duty @ Rs. 8/- per connection per month leviable on cable TV operators has been
abolished.
Zero-rating of sales tax on uncooked poultry meat.
• To decrease the cost of doing business for the organized sector in poultry meat
processing, sales tax on uncooked poultry meat has been zero-rated.
Exemption of sales tax on surgical tapes and ultrasound gel.
• Medicines are exempt from sales tax. Therefore, the scope of exemption has been
extended to two more medicinal items which are surgical tapes and ultrasound gel.
REVENUE MEASURES
Extension of scope of excise duty on financial services
• The existing levy of excise duty @ 5% on non-fund banking services is being extended to
include all non-fund services except cheque book issuance charges, Umra and Hajj service
charges, cheque return charges and utility collection charges.
Rationalization of excise duty on international air travel.
• For the facilitation of passengers various levies on international air travel i.e. excise duty,
foreign travel tax and Government airport tax are being clubbed together in the name of Air
Travel Tax. (ATT). The rate is same but exemption for passenger coming from abroad is
being withdrawn.
Increase in retail price of cigarettes to increase the incidence of tax.
• Cigarettes are chargeable to excise duty on the basis of retail price. To complement the
growth in cigarette industry and to enhance excise duty collection without disturbing the

12. present three tier system for the purposes of levy, retail price of cigarettes is increased by
7%.
Increase in rate of sales tax from 15% to 20% on specified raw materials.
• To discourage the informal manufacturing in iron and steel, plastics and paper, the rate of
sales tax on import and supply of their raw materials as well as some specified chemicals is
being increased from 15% to 20% which will induce the informal manufacturing sector to
be compliant to obtain input tax adjustment as the end products remain chargeable to sales
tax @ 15%.
Withdrawal of input tax adjustment on the supply of utilities (electricity and gas) to
the residential colonies of manufacturers.
• In the light of best VAT practices, input tax adjustment is being disallowed on supply of
utilities (electricity and gas) to the residential colonies of manufacturers. This measure will
also settle many legal disputes.
Withdrawal of zero-rating of chemicals of multiple usage.
• Under SRO 525(I)/2006, a large number of chemicals used in the five major export
oriented sectors have been zero-rated. Keeping in view the multiple usage of some of the
chemicals are also used in other industries, such chemicals are being taken out of zero-
rating notification.
Collection of sales tax of CNG stations from gas distribution Companies.
• To rationalize the collection of sales tax on supplies made by CNG stations, the
responsibility to charge and deposit sales tax is being given to the gas distribution
companies. CNG stations will not be required to remain registered with sales tax or keep
any records.
STREAMLINING MEASURES
Abolition of sales tax on advance payments
• To simply the sales tax regime, sales tax leviable on advance payments received by
registered persons is being abolished. Now the registered persons shall be required to
charge sales tax at the time of delivery of goods.
Restriction of input tax adjustment
• To check the mal-practices in input tax adjustment, the adjustment of input tax is being
restricted to 90% of output tax. The system of adjustment notes and adjustment advices
causing problems for the taxpayer is being abolished.

13. Provisions for payment of sales tax refund along with duty drawback.
• The scope of sales tax refund is now being limited to zero-rated supplies or exports only.
A scheme is being envisaged whereby the exporters of five zero-rated sectors shall be able
to obtain sales tax refund on packing material, chemicals along with customs duty
drawback.
Withdrawal of special procedures for commercial importers, iron & steel sector,
restaurants, biscuits and confectionery.
• With a view to remove distortions in the sales tax system a number of special treatment
procedures are being abolished. Now commercial importers, iron & steel sector, restaurants
and biscuit and confectionery sector shall operate in standard sales tax procedure of
payment of due tax after adjusting the input tax on purchases from the output tax charged
on supplies.
Introduction of concept of withholding agents in sales tax.
• To plug the revenue gap in Government supplies and to collect the due tax from general
orders supplies and wholesalers, the system of withholding of sales tax by the Government
agencies is being introduced
.
Immediate refunds to Large Taxpayers against bank guarantees.
• To expedite the sales tax refunds of large taxpayers registered in Large Taxpayers Units, a
new procedure has been issued whereby they can claim their sales tax refunds within three
days of filing upon submission bank guarantee equivalent to refund amounts.
Enhancement in period of record retention.
• Based on international best practices, the period of record retention is being enhanced to
five years from existing three years.
Single sales tax return.
• Abolishing the various sales tax returns and a separate invoice summary, a single sales
tax return has been introduced and invoice summary has been made an annexure to the
return for facilitation.
Levy and deposit of excise duty in the manner of sales tax.
• Excise duty shall now be leviable on supplies instead of clearance as done in sales tax and
shall be deposited with the return on the 15th day of the following month.
Linkage of registration threshold of manufacturers with utility bills.
• Apart from the existing registration threshold of supplies of Rs. 5 million per annum, a
new parameter based on utility bills is being introduced by amending the Sales Tax Act,

14. 1990. Whereby the manufacturers having utility bills of more than Rs. 600,000 per annum
shall also be required to obtain sales tax registration.
SALIENT FEATURES FOR THE BUDGET 2007 DIRECT
TAXES.
A. RELIEF MEASURES:
1. Present corporate tax rate of 35% to continue.
2. Income of Micro Finance Banks (MFBs) exempted from tax for five years.
3. Withholding tax on passenger transport services reduced from 6% to 2% on the analogy
of goods transport services.
4. Exemption under clause (132) of Part I of Second Schedule extended to companies
owning and managing Hydel Power Projects situated in AJ&K.
5. Companies operating Hotels in Pakistan or AJ&K are allowed set off of losses arising
in Pakistan or AJ&K against income in Pakistan or AJ&K and vice versa as the case
may be.
6. Exemption of tax on capital gains extended for further one year.
7. Withdrawal of 2% withholding tax over and above the prescribed rate on supplies for
non-disclosure of NTN or CNIC to withholding agent.
8. Mergers and Acquisitions to be treated as non tax event.
9. Withholding tax rate on all exports to be unified @ 1%.
10. Permanent Establishments of non-resident Exploration and Production Companies
exempted from withholding tax on supply of crude oil and gas.
11. E&P Companies exempted from WHT on imports (other than vehicles).
12. Review of Law Relating to Holding Companies.
• 75% share holding required if none of the companies is a public listed limited company.
• 55% share holding required if one of the group companies is a public listed limited
company.
• Group relief restricted to domestic companies.
• Companies engaged in trading will not qualify for relief.

15. • Current tax year losses can be surrendered by holding company to a subsidiary or
between subsidiaries which fulfill the requirements of share holding;
• Inter corporate dividend - liable to 10% adjustable withholding tax.
13. Group Taxation/Relief:
• For group formation, transfer of shares between companies and the owners in one
direction to be treated as non-tax event.
• Group taxation to be restricted to locally registered companies under Companies
Ordinance, 1984 domestic companies.
14. CNIC to be used for identification purpose, as an alternate, where NTN is not obtained.
15. Replacing Venture Capital Funds with Private Equity and Venture Capital Funds -
exemption extended to the Fund up to June 2014.
16. Capital Gains of private limited companies on sale of their assets to private equity and
Venture Capital Funds to be taxed @ 10% (reduced tax rate).
17. Income arising on sale of immoveable property to Real Estate Investment Trust (REIT),
exempted from tax for three years.
18. Separate tax regime for retailers:
Turnover Rate of Tax
- Up to Rs. 05 million 0.5%
- From 05 to 10 million Rs. 25,000 plus 0.5% of the amount of turnover exceeding Rs. 5
million
- Above Rs. 10 million Rs.50, 000 plus 0.75% of the amounting of turnover exceeding
Rs.10 million
19. Separate Schedule for Banking Companies introduced.
20. Maximum limit of investment in IPOs to avail tax credit enhanced from Rs. 200,000 to
300,000.
21. Presumptive Tax Regime introduced for service providers to exporters/export house
under the Trade Policy withdrawn.
22. Set off of brought forwarded losses in the event of amalgamation/merger of companies
withdrawn.
23. Withholding tax on sale of goods made adjustable for listed public companies.

16. 24. Tax in respect of income from construction contracts out side Pakistan to be charged at
the rate of one per cent of the gross receipts provided that such income is brought into
Pakistan in foreign exchange through normal banking channel.”
25. Withdrawal of withholding tax on payments to travel agents on sale of air tickets where
withholding tax on commission is already deducted.
26. Payments received by non-resident news agencies, syndicate services and individual
contributors/writers not having permanent establishment in Pakistan will not be subjected
to withholding tax on services provided.
27. Advertising services provided by owners ofnewspapers/magazines in the non-corporate
sector taken out of Presumptive Tax Regime.
28. Withdrawal of CVT on import of cars and power of attorney executed between first
relations.
29. Withholding tax @ 5% on purchase of locally manufactured cars.
30. Federal Excise duty also to be included in the value of goods for withholding tax
purposes at the import stage.
B. RATIONALIZATION OF WITHHOLDING TAXES REGIME:
31. Withholding Tax on Imports.
• For commercial importers covered under PTR, WHT rate reduced from 6% to 5%.
• For manufacturers a uniform adjustable withholding tax on imports @ 1%.
• Exemption in respect of imports covered by statutory provisions will continue.
• Taxpayers having losses or those having paid advance tax eligible for reduced rate
exemption certificates on imports.
• Manufacturer exporters registered with Sales Tax Department not liable to withholding
tax on imports.
• Withholding tax on import of edible oil reduced from
3% to 2%.
• Import of polyester filament fiber yarn to be subjected to 5% withholding tax.
• Import of Bitumen, pesticides/wedicides and FWT to be subjected at reduced withholding
tax rate of 2%.
32. Employers authorized to give credit of tax withheld from employees under different
withholding provisions during the tax year. Also authorized to adjust tax credit allowable to
salaried taxpayers having salary income only.
33. Ginners provided option to pay WHT at the prescribe rate.
34. Exclusion of companies (Large Import Houses) importing bulk industrial raw material
from presumptive tax regime.

17. 35. Professional Firms to be taxed at par with other AOPs.
C. REVENUE GENERATION:
36. Withholding tax on non-corporate commercial and industrial consumers of electricity
made minimum tax liability.
37. Withdrawal of exemption to Mutual Fund on CFS interest income.
38. Companies to pay advance tax in the first year of operations.
D. SIMPLIFICATION:
39. Small company redefined with following characteristics;
- Paid up capital = 25 (M)
- Annual Sales = 250 (M)
- Employment Limit = 250 persons
40. Presumptive tax regime for Compressed Natural Gas (CNG) stations and withholding
tax @ 6% of gas bill.
E. DOCUMENTATION:
41. Electronic filing of returns and withholding statements for corporate taxpayer made
mandatory.
42. Filing of Wealth Statement – mandatory for taxpayers having income of Rs. 500,000/-
or more – Commissioner authorized to call for the Wealth Statement.
SALIENT FEATURES 2008 budget CUSTOMS BUDGETARY
MEASURES 2008-09
Policy Objectives:
1• Industrial incentives for growth and expansion.
2• Discouraging import of non-essential and luxury items.
3• Minimizing the cost of doing business.
4• Cascading principle in tariff rates maintained as guiding principle (primary raw
materials @ 0%-5%, secondary/components @ 5-10% and finished goods @ 20-35%).
5• Amendments in Customs Act, Rules and Procedures for further simplification.
Relief Measures:
• The local industry producing water dispensers, hooks & eyes, aluminum alloy, electric
irons, mini choppers, vacuum cleaners, central heating gas boilers, mini ovens, gas heaters,
gas stoves/cooking ranges with ovens, air handling equipments, central heating

18. equipments, UPS, Chlorinated paraffin, chrysotile cement pipes, sheets & fittings and
perforated steel products have been provided inputs at 0%, 5% and 10% rates of duty.
1
2• Fully dedicated CNG buses exempted of from duty.
3• Pharmaceutical industry given specified active ingredients, chemicals and packing
materials at 5% duty.
4• Eighteen medicines used for cancer/heart treatment etc. exempted from customs
duty.
5• Bitumen, JP4&JP8 exempted from duty. Duty rate on base oil for lubricating oils
reduced from 20% to 10%.
6• Rice seeds, energy saving lamps, dredgers, specified solar energy equipments
exempted from customs duty.
7• Power plants imported by WAPDA on temporary basis exempted from customs
duty.
• Reduction of duty on calcium carbide from 15% to 5%, PTA from 15% TO 7.5%,
PSF 6.5% to 4.5%, Caustic soda from Rs.5000/MT to Rs.4000/MT, Printing
screens from 15% to 10%, nickel not alloyed from 5% to 0%, Textile buckram from
25% to 10%.
8• Manufacturers have been allowed to import samples duty free as per specified
conditions in chapter 99 of PCT.
9• Seized/confiscated vehicles as on 31st May, 2008 may be released against payment of
leviable duty/taxes and 30% redemption fine.
Revenue measures:
1
2• Duty rates on non-essential & luxury items have been increased. Hence, duty rate on
dairy products, fruits, chewing gum, chocolate, processed food, fruit juices, aerated
waters, ceramic products, air-conditioners/refrigerators, electric fans, toasters, micro
wave ovens, televisions, furniture and lighting equipment etc increased from 25% to
35%. Duty rates on cosmetics increased from 20 -25% to 35%. Duty rate on electric
ovens/ cooking ranges etc. increased from 20% to 30%.
3• Customs duty @ Rs. 500/ per set levied on import of mobile phone.
4• Customs duty on betel leaves increased from Rs.150/kg to Rs. 200/kg.
5• Duty rate increased on sulphonic acid from 10% to 15%.
6• Duty rate increased on CKD/SKD of sewing machines from 5% to 20%
7• A uniform rate of 30% specified for import of special purpose motor vehicles.
8• Increase in duty rates on import of cars/jeeps above 1800cc from 90% to 100%.
Fixed duty/tax rates on old and used cars/jeeps increased by 10%.
Investment /trade facilitative measures:
1

19. 2• Manufacturers and particularly soap manufacturers based in AJ&K have been
extended concessionary duty regime in line with SRO 565(I)/2006, as available to
Pakistan based manufacturers.
3• Specified industries/projects have been de-linked from the local manufacturing
condition for import of required machinery, equipments and raw materials etc.
4• Tariff based system (TBS) for auto sector has further been improved.
5• Release of held up indemnity bonds is eased out.
Legal changes:
Following amendments have been proposed in the Customs Act, 1969:
1
2• Clause (ab) in section 21 of the Customs Act proposed to be omitted.
3• A new section 3DD is proposed to be introduced in the Customs Act, 1969 for
constituting a Directorate General of Post Clearance Audit (PCA)
4• A proviso is proposed to be added to section 155F of the Customs Act for
suspension of unique user identifier of any person.
5• Section 156 is proposed to be amended to provide for penalizing the custodian of
any goods for involvement in an offence under the Customs Act.
6• Section 179 of the Customs Act is proposed to be amended for allowing
adjudicating officers to decide cases within 120 days.
7• Section 194C is proposed to be amended for enhancing the limit of single bench
of the Appellate Tribunal from five to ten million rupees.
8• A new sub-section 4A is proposed to be added in section 195C for redresser of
grievances of an aggrieved person
June 10, 2008
SALIENT FEATURES OF THE BUDGET 2008 RELIEF
MEASURES:
11. The basic limit of exemption from income tax in respect of salaried person is proposed
to be increased from Rs.150, 000 to Rs.180, 000. In the case of women salaried taxpayer
the basic exemption limit is proposed to be increased from Rs.200, 000 to Rs.240, 000.
12. The concept of marginal tax relief for the salaried persons is being introduced to cater
for the negative impact of taxation under the present flat tax rate system. The marginal
increase in salary income is proposed to be taxed at the rates not exceeding 20% to 50%
allowing sufficient relief in tax payable.
13. Minimum tax payable on the declared turnover @ 0.5% is being proposed to be
withdrawn.
14. In future instead of tax holidays, First Year Allowance in the shape of accelerated
depreciation @ 90% is proposed to be allowed to the industrial undertakings established in
the specified rural and undeveloped areas.

20. 15. The value of accommodation provided to the salaried persons in small cities is
proposed to be taken at 30% instead of 45% of the minimum time scale of the employees
for the purpose of taxation.
16. At present inter corporate dividend in respect of companies entitled to group relief
under section 59AA is exempt from tax. The facility is proposed to be extended to the
companies eligible for group taxation under section 59B.
17. Exemption available to capital gain on shares of listed companies up to the tax year
ending 30th June 2008 is proposed to be extended to 30th June 2010 without any change in
the withholding tax and CVT regime.
18. To encourage amalgamation of banking companies, modarabas and insurance
companies the facility of carry forward of “accumulated loss” is proposed to be allowed for
a period of six years in the case of amalgamated or amalgamating companies.
19. Rice Exporters Association of Pakistan (REAP) is proposed to be allowed the facility
of reduced withholding tax rate of 1% in respect of payments payable for supply of rice to
M/s Utility Stores Corporation.
110. Income derived by a project approved by Designated National Authority (DNA) from
transfer/sale of CDM emissions credit i.e. Certified Emissions Reduction (CER) etc is
being proposed to be exempt from income tax.
111. In the case of bank no CVT is proposed to be charged on General Power of Attorney
unless it is used into force the mortgage of property offered as collateral against a loan.
112. In the case of a small company if turnover exceeds Rs.250 million, the income
attributable to the turnover exceeding the said limit, is proposed to be charged to tax at
progressive slab rate of 25%, 30% and 35%, so that the company is able to progress still
retaining its status of a “small company”.
113. Income shown as unrealized gains in the case of non life insurance companies would
be excluded from the taxable income and not charged to tax.
114. Proportionate relief is proposed to be allowed in the amount of penalty imposed in tax
evasion cases where the appellate authorities reduce the quantum of concealed income and
tax charged thereon.
115. A scheme for waiver of additional tax and penalty etc. is proposed to be introduced
where the taxpayer is able to pay the principal amount of tax within a certain period.
REVENUE MEASURES:
1

21. 216 At present gross rental income from property is chargeable to tax at a flat rate of 5%. It
is proposed that no tax my be charged on income up to Rs.150, 000 and tax income from
this source on progressive rates of 5%, 10 and 15%. However, in the case of a company
basic exemption of Rs.150, 000 would not be available.
117 At present withholding tax rate of 5% and 1% is applicable in respect of commercial
and manufacturer importers respectively. It is proposed to apply a uniform rate of 2% for
both the categories of importers.
118 Withholding tax collected on electricity bills is being rationalized to collect the same
@ 10% on bill amount exceeding Rs.20,000 per month which would be adjustable.
Withholding Tax on bull amount of Rs.2000 and below would be collected at the previous
rates.
119 The pensioners, senior citizens and widows who are exempt from withholding tax in
respect of profit from pensioners benefit scheme and
1behold fund would not be charged to tax at a rate not exceeding 10% of such profit.
120. Exemption from income tax available to Pakistan Cricket Board is proposed to be
withdrawn.
121. In order to encourage and promote investment in the business and industries, scheme
of investment tax is being introduced, allowing immunity from probe in respect of any
moveable and immoveable assets on the value of which tax @ 2% is paid.
122. The rates of advance tax, collected at the time of renewal of registration of private
motor cars, are proposed to be rationalized by making about 30% to 40% Increase in WHT
rates.
123. Withholding tax on monthly telephone bills exceeding Rs.1000 is proposed to be
collected @ 10%.
124. Association of person and individuals having annual turnover of Rs.50 million
respectively are proposed to be made withholding tax agents for the purpose of tax
deduction on payments relating to on sale of goods, services rendered and execution of
contracts.
125. The existing exemption regime provided under the Second Schedule of the Income
Tax Ordinance, has been reviewed to delete all redundant and unjustified exemptions.
126. Profit transferred by a branch of foreign company out of Pakistan are proposed to be
treated as dividend and chargeable to tax @ 10% as final tax.

22. 127. The limit of donations eligible for tax credit in the case of individual/association of
persons and companies presently admissible @ 30% and 15% respectively are proposed to
be reduced to 10% of the taxable income.
128. It has been proposed that reinsurance premium paid to overseas insurance companies
may be subjected to withholding tax @ 5% which would be a final tax.
129. Withholding tax on cash withdrawal from banks presently collected @ 0.2% is
proposed to be collected @ 0.3% on cash withdrawal.
130. A new taxation system is being introduced for builders and developers, whereby the
builder would be required to pay tax @ Rs.50 per sq. ft. of the covered area of a unit. The
developer of open plots would be subjected to tax @ Rs.100 per sq. yard of the plot.
131. The facility of reduced tax rate to a cooperative society or a finance society is
proposed to be withdrawn and would be treated at par with the company for the purpose of
taxation.
132. Exemptions from income tax available under the other statutes are proposed to be
withdrawn unless provided specifically under 2nd Schedule to the Income Tax Ordinance,
2001.
133. Payments made to media companies out side Pakistan are proposed to be subjected to
WHT @ 10%, to be treated as final tax.
134. Any payment made through a foreign currency account and exchange companies
proposed to be included in the payments requiring deduction of WHT unless the CIT has
allowed otherwise as provided under section 152 of Income Tax Ordinance, 2001.
135. From the next financial year WHT on purchase of locally manufactured motor car or
jeep is proposed to be collected by a motor vehicle registration authority at fixed rates
depending on the engine capacity.
136. Thin capitalization rule is proposed to be made applicable to branches of foreign
companies operating in Pakistan.
137. The discrimination in tax rates applicable to exporters is being removed by withdrawal
of provisions allowing deduction of tax at a rate lesser than 1%.
138. The tax collected from the members of stock exchange on sale as well as purchase of
shares in lieu of commission income and trading of share is proposed to be made a
minimum tax on income of such members/ brokers.
TECHNICAL MEASURES:

23. 139. The period of payment of tax due from a taxpayer is being reduced from 30 days to 15
days.
140. The provisions of section 115 of the Income Tax Ordinance, 2001 are proposed to be
amended so as to ensure filing of wealth statement by a salaried taxpayer whose income is
more than Rs.500, 000 even if he is not required to file a return of income.
141. Sub-section (6A) of section 153 is being amended to clearly state the intention of
legislature that tax deducted in the case of non-corporate
1taxpayers on supply of manufactured goods shall be a final tax. Sub-section (6B) is
proposed to be deleted.
142. To bring clarity in law, clause (46) of Part I of the 2nd Schedule to the Income Tax
Ordinance, 2001 is being amended so that exemption is provided from deduction of tax on
supplies made by PE of non-resident E&P companies.
143. To ensure correct recording of sale, Electronic Tax Register (ETR) are planned to be
installed at selected wholesale and retail outlets with known high volume of business. For
the purpose amendment is being proposed to be made in the Income Tax Law and Rules.
144. In order to ensure quick disposal of cases remanded back by the ITAT to the CIT (A)
for making a fresh order, a limitation of six months is being provided in the law.
145. The limit for payment of salary to be paid by an employer through cheque or transfer
to employee’s account is being increased from Rs.10,000 to Rs.15,000.
146. A time limit of 90 days is being provided under the Income Tax Rules, 2002 for
making an order by the FBR on receipt of recommendations from the Alternate Dispute
Resolution Committee (ADRC).
147. In case of withdrawals from superannuation fund liable to WHT the deduction of tax
is proposed to be made at the rate applicable to the year of withdrawal instead of average
rate of the preceding three years.
148. In order to create linkages between voluntary and occupational savings schemes, the
subscriber of a Recognized Provident Fund is proposed to be allowed to transfer funds to a
voluntary pension fund scheme.
149. The provisions of 7th Schedule allowing deduction on account of non-performing loans
as per prudential regulation issued by the SBP are proposed to be deleted. From the next
financial year such deductions would be allowed under sections 29 and 29A of the Income
Tax Ordinance, 2001.

24. 150. A person making payment to a non-resident would not be required to give a notice to
the CIT under section 152(5) of the Income Tax Ordinance, 2001, if no withholding or
withholding of tax at a lesser rate is provided under the avoidance of double taxation treaty.
151. Enabling powers are proposed to be given to the FBR to allow exemption from
Withholding taxes required under different provisions of the Ordinance.
152. The term “local authority” as used in section 49 and elsewhere in the Income Tax
Ordinance is proposed to be substituted by the term “Local Government” to bring clarity in
the law regarding exemption from income tax.
153. The definition of “Urban Area” as given under section 7 of the Finance Act, 1989 for
the purpose of levy of CVT is being amended to bring it in consonance with the changes
made as a result of devolution plan

25. MONETARY POLICY
Monetary Policy is the process by which the government, central bank, or monetary
authority of a country controls
 Supply of money
 Availability of money
 Cost of money or rate of interest,
In the words of Harry G. Johnson, quot;It is a policy of Central Bank to control the supply
of money with the aim of achieving macroeconomic stabilityquot;.
Monetary policy is one of the tools that a national Government uses to influence its
economy. Using its monetary authority to control the supply and availability of money, a
government attempts to influence the overall level of economic activity in line with its
political objectives. Usually this goal is quot;macroeconomic stabilityquot; - low unemployment,
low inflation, economic growth, and a balance of external payments. Monetary policy is
usually administered by a Government appointed quot;Central Bankquot;.
Monetary policy is generally referred to as either being an expansionary policy, or a
contractionary policy, where an expansionary policy increases the total supply of money in
the economy, and a contractionary policy decreases the total money supply. Expansionary
policy is traditionally used to combat unemployment in a recession by lowering interest
rates, while contractionary policy involves raising interest rates in order to combat
inflation. Monetary policy should be contrasted with fiscal policy, which refers to
government borrowing, spending and taxation.
Overview
Monetary policy rests on the relationship between the rates of interest in an economy, that
is the price at which money can be borrowed, and the total supply of money. Monetary
policy uses a variety of tools to control one or both of these, to influence outcomes like
economic growth, inflation, exchange rates with other currencies and unemployment.
Where currency is under a monopoly of issuance, or where there is a regulated system of
issuing currency through banks which are tied to a central bank, the monetary authority has
the ability to alter the money supply and thus influence the interest rate (in order to achieve
policy goals).
A policy is referred to as contractionary if it reduces the size of the money supply or raises
the interest rate. An expansionary policy increases the size of the money supply, or
decreases the interest rate. Further monetary policies are described as accommodative if the
interest rate set by the central monetary authority is intended to spur economic growth,

26. neutral if it is intended to neither spur growth nor combat inflation, or tight if intended to
reduce inflation.
There are several monetary policy tools available to achieve these ends. Increasing interest
rates by fiat, reducing the monetary base, and increasing reserve requirements all have the
effect of contracting the money supply, and, if reversed, expand the money supply.
Within almost all modern nations, special institutions (such as the Bank of England, the
European Central Bank, the Federal Reserve System in the United States, the Bank of
Japan or Nippon Ginkō, the Bank of Canada or the Reserve Bank of Australia) exist which
have the task of executing the monetary policy and often independently of the executive. In
general, these institutions are called central banks and often have other responsibilities such
as supervising the smooth operation of the financial system.
The primary tool of monetary policy is open market operations. This entails managing the
quantity of money in circulation through the buying and selling of various credit
instruments, foreign currencies or commodities. All of these purchases or sales result in
more or less base currency entering or leaving market circulation.
Usually the short term goal of open market operations is to achieve a specific short term
interest rate target. In other instances, however, monetary policy might instead entail the
targeting of a specific exchange rate relative to some foreign currency or else relative to
gold. For example in the case of the USA the Federal Reserve targets the federal funds rate,
the rate at which member banks lend to one another overnight. However the monetary
policy of China is to target the exchange rate between the Chinese renminbi and a basket of
foreign currencies.
The other primary means of conducting monetary policy include:
 Discount window lending - lender of last resort
 Fractional deposit lending - changes in the reserve requirement
 Moral suasion- cajoling certain market players to achieve specified outcomes
 quot;Open mouth operations- talking monetary policy with the market
History of Monetary Policy
Monetary policy is primarily associated with interest rate and credit. For many centuries
there were only two forms of monetary policy: Decisions about coinage; Decisions to print
paper money to create credit. Interest rates, while now thought of as part of monetary
authority, were not generally coordinated with the other forms of monetary policy during
this time. Monetary policy was seen as an executive decision, and was generally in the
hands of the authority with seigniorage, or the power to coin. With the advent of larger
trading networks came the ability to set the price between gold and silver, and the price of
the local currency to foreign currencies. This official price could be enforced by law, even
if it varied from the market price.

27. With the creation of the Bank of England in 1694, which acquired the responsibility to
print notes and back them with gold, the idea of monetary policy as independent of
executive action began to be established. The goal of monetary policy was to maintain the
value of the coinage, print notes which would trade at par to specie, and prevent coins from
leaving circulation. The establishment of central banks by industrializing nations was
associated then with the desire to maintain the nation's peg to the gold standard, and to
trade in a narrow band with other gold-backed currencies. To accomplish this end, central
banks as part of the gold standard began setting the interest rates that they charged, both
their own borrowers, and other banks that required liquidity. The maintenance of a gold
standard required almost monthly adjustments of interest rates.
During the 1870-1920 periods the industrialized nations set up central banking systems,
with one of the last being the Federal Reserve in 1913. By this point the understanding of
the central bank as the quot;lender of last resortquot; was understood. It was also increasingly
understood that interest rates had an effect on the entire economy, in no small part because
of the marginal revolution in economics, which focused on how many more, or how many
fewer, people would make a decision based on a change in the economic trade-offs. It also
became clear that there was a business cycle, and economic theory began understanding the
relationship of interest rates to that cycle.
The advancement of monetary policy as a pseudo scientific discipline has been quite rapid
in the last 150 years, and it has increased especially rapidly in the last 50 years. Monetary
policy has grown from simply increasing the monetary supply enough to keep up with both
population growth and economic activity. It must now take into account such diverse
factors as:
 Short Term Interest Rates
 Long Term Interest Rates
 Velocity of Money through the Economy
 Exchange Rates
 Credit Quality
 Bonds and Equities (corporate ownership and debt)
 Government versus Private Sector Spending/Savings
 International Capital Flows of Money on large Scales
 Financial Derivatives such as Options, Swaps, Futures Contracts, etc.
A small but vocal group of people advocate for a return to the gold standard (the
elimination of the dollar's fiat currency status and even of the Federal Reserve Bank). Their
argument is basically that monetary policy is fraught with risk and these risks will result in
drastic harm to the populace should monetary policy fail. Others see another problem with
our current monetary policy. The problem for them is not that our money has nothing
physical to define its value, but that fractional reserve lending of that money as a debt to

28. the recipient, rather than a credit, causes all but a small proportion of society (including all
governments) to be perpetually in debt.
In fact, many economists disagree with returning to a gold standard. They argue that doing
so would drastically limit the money supply, and throw away 100 years of advancement in
monetary policy. The sometimes complex financial transactions that make big business
(especially international business) easier and safer would be much more difficult if not
impossible. Moreover, shifting risk to different people/companies that specialize in
monitoring and using risk can turn any financial risk into a known dollar amount and
therefore make business predictable and more profitable for everyone involved.
Effectiveness of Monetary Policy
Economists debate the relevant measures of money supply.
• Narrow Money Supply or M1 is currency in circulation and the currency in easily
accessed chequing and savings accounts.
• Broader Money Supply measures such as M2 and M3 include term deposits and
even money market mutual funds.
Economists debate the finer points of the implementation and effectiveness of monetary
policy but one thing is obvious. At the extremes, monetary policy is a potent force. In
countries such as the Russian Republic, Poland or Brazil where the printing presses run full
tilt to pay for government operations, money supply is expanding rapidly and the currency
becomes rapidly worthless compared to goods and services it can buy. Very high levels of
inflation or quot;hyperinflationquot; is the result. With 30-40% monthly inflation rates, citizens buy
hard goods as soon as they receive payment in the currency and those on fixed income have
their investments rendered worthless.
At the other extreme, restrictive monetary policy has shown its effectiveness with
considerable force. Germany, which experienced hyperinflation during the Weimar
Republic and never forgot, has maintained a very stable monetary regime and resulting low
levels of inflation. When Chairman Paul Volcker of the U.S. Federal Reserve applied the
monetary brakes during the high inflation 1980s, the result was an economic downturn and
a large drop in inflation.
Without much debate, the effectiveness of monetary policy, its timing and its eventual
impacts on the economy are not obvious. That central banks attempt influence the economy
through monetary is a given. In any event, insights into monetary policy are very important
to the investor. The availability of money and credit are key considerations in the pricing of
an investment.
Trends in Central Banking

29. The central bank influences interest rates by expanding or contracting the monetary base,
which consists of currency in circulation and banks' reserves on deposit at the central bank.
The primary way that the central bank can affect the monetary base is by open market
operations or sales and purchases of second hand government debt, or by changing the
reserve requirements.
If the central bank wishes to lower interest rates, it purchases government debt, thereby
increasing the amount of cash in circulation or crediting banks' reserve accounts.
Alternatively, it can lower the interest rate on discounts or overdrafts (loans to banks
secured by suitable collateral, specified by the central bank). If the interest rate on such
transactions is sufficiently low, commercial banks can borrow from the central bank to
meet reserve requirements and use the additional liquidity to expand their balance sheets,
increasing the credit available to the economy. Lowering reserve requirements has a similar
effect, freeing up funds for banks to increase loans or buy other profitable assets.
A central bank can only operate a truly independent monetary policy when the exchange
rate is floating. If the exchange rate is pegged or managed in any way, the central bank will
have to purchase or sell foreign exchange. These transactions in foreign exchange will have
an effect on the monetary base analogous to open market purchases and sales of
government debt; if the central bank buys foreign exchange, the monetary base expands,
and vice versa. But even in the case of a pure floating exchange rate, central banks and
monetary authorities can at best quot;lean against the windquot; in a world where capital is mobile.
Accordingly, the management of the exchange rate will influence domestic monetary
conditions. In order to maintain its monetary policy target, the central bank will have to
sterilize or offset its foreign exchange operations. For example, if a central bank buys
foreign exchange (to counteract appreciation of the exchange rate), base money will
increase. Therefore, to sterilize that increase, the central bank must also sell government
debt to contract the monetary base by an equal amount. It follows that turbulent activity in
foreign exchange markets can cause a central bank to lose control of domestic monetary
policy when it is also managing the exchange rate.
In the 1980s, many economists began to believe that making a nation's central bank
independent of the rest of executive government is the best way to ensure an optimal
monetary policy, and those central banks which did not have independence began to gain it.
This is to avoid overt manipulation of the tools of monetary policies to effect political
goals, such as re-electing the current government. Independence typically means that the
members of the committee which conducts monetary policy have long, fixed terms.
Obviously, this is a somewhat limited independence.
In the 1990s central banks began adopting formal, public inflation targets with the goal of
making the outcomes, if not the process, of monetary policy more transparent. That is, a
central bank may have an inflation target of 2% for a given year, and if inflation turns out
to be 5%, then the central bank will typically have to submit an explanation.

30. The Bank of England exemplifies both these trends. It became independent of government
through the Bank of England Act 1998 and adopted an inflation target of 2.5% RPI (now
2% of CPI).
The debate rages on about whether monetary policy can smooth business cycles or not. A
central conjecture of Keynesian economics is that the central bank can stimulate aggregate
demand in the short run, because a significant number of prices in the economy are fixed in
the short run and firms will produce as many goods and services as are demanded (in the
long run, however, money is neutral, as in the neoclassical model).
Developing Countries
Developing countries may have problems establishing an effective operating monetary
policy. The primary difficulty is that few developing countries have deep markets in
government debt. The matter is further complicated by the difficulties in forecasting money
demand and fiscal pressure to levy the inflation tax by expanding the monetary base
rapidly. In general, the central banks in many developing countries have poor records in
managing monetary policy. This is often because the monetary authority in a developing
country is not independent of government, so good monetary policy takes a backseat to the
political desires of the government or are used to pursue other non-monetary goals.
For this and other reasons, developing countries that want to establish credible monetary
policy may institute a currency board or adopt dollarisation. Such forms of monetary
institutions thus essentially tie the hands of the government from interference and, it is
hoped, that such policies will import the monetary policy of the anchor nation.
However, recent attempts at liberalising and reforming the financial markets (particularly
the recapitalisation of banks and other financial institutions in Nigeria and elsewhere) are
gradually providing the leeway required to implement monetary policy frameworks by the
relevant central banks.
Types of Monetary Policy
In practice all types of monetary policy involve modifying the amount of base currency
(M0) in circulation. This process of changing the liquidity of base currency through the
open sales and purchases of (government-issued) debt and credit instruments is called open
market operations.
Constant market transactions by the monetary authority modify the supply of currency and
this impacts other market variables such as short term interest rates and the exchange rate.
The distinction between the various types of monetary policy lies primarily with the set of
instruments and target variables that are used by the monetary authority to achieve their
goals.

31. Monetary Policy Target Market Variable Long Term Objective
Inflation Targeting Interest rate on overnight A given rate of change in the CPI
debt
Price Level Targeting Interest rate on overnight A specific CPI number
debt
Monetary Aggregates The growth in money A given rate of change in the CPI
supply
Fixed Exchange Rate The spot price of the The spot price of the currency
currency
Gold Standard The spot price of gold Low inflation as measured by the
gold price
Mixed Policy Usually interest rates Usually unemployment + CPI change
The different types of policy are also called monetary regimes, in parallel to exchange rate
regimes. A fixed exchange rate is also an exchange rate regime; The Gold standard results
in a relatively fixed regime towards the currency of other countries on the gold standard
and a floating regime towards those that are not.
Targeting inflation, the price level or other monetary aggregates implies floating exchange
rate unless the management of the relevant foreign currencies is tracking the exact same
variables (such as a harmonised consumer price index).
Inflation Targeting
Under this policy approach the target is to keep inflation, under a particular definition such
as Consumer Price Index, within a desired range.
The inflation target is achieved through periodic adjustments to the Central Bank interest
rate target. The interest rate used is generally the interbank rate at which banks lend to each
other overnight for cash flow purposes. Depending on the country this particular interest
rate might be called the cash rate or something similar.
The interest rate target is maintained for a specific duration using open market operations.
Typically the duration that the interest rate target is kept constant will vary between months
and years. This interest rate target is usually reviewed on a monthly or quarterly basis by a
policy committee.
Changes to the interest rate target are made in response to various market indicators in an
attempt to forecast economic trends and in so doing keep the market on track towards
achieving the defined inflation target. For example, one simple method of inflation
targeting called the Taylor rule adjusts the interest rate in response to changes in the

32. inflation rate and the output gap. The rule was proposed by John B. Taylor of Stanford
University.
Price Level Targeting
Price level targeting is similar to inflation targeting except that CPI growth in one year is
offset in subsequent years such that over time the price level on aggregate does not move.
Something akin to price level targeting was tried by Sweden in the 1930s, and seems to
have contributed to the relatively good performance of the Swedish economy during the
Great Depression. As of 2004, no country operates monetary policy based on a price level
target.
Monetary Aggregates
In the 1980s several countries used an approach based on a constant growth in the money
supply. This approach was refined to include different classes of money and credit (M0,
M1 etc). In the USA this approach to monetary policy was discontinued with the selection
of Alan Greenspan as Fed Chairman.
This approach is also sometimes called monetarism.
Whilst most monetary policy focuses on a price signal of one form or another this approach
is focused on monetary quantities.
Fixed Exchange Rate
This policy is based on maintaining a fixed exchange rate with a foreign currency. There
are varying degrees of fixed exchange rates, which can be ranked in relation to how rigid
the fixed exchange rate is with the anchor nation.
Under a system of fiat fixed rates, the local government or monetary authority declares a
fixed exchange rate but does not actively buy or sell currency to maintain the rate. Instead,
the rate is enforced by non-convertibility measures (e.g. capital controls, import/export
licenses, etc.). In this case there is a black market exchange rate where the currency trades
at its market/unofficial rate.
Under a system of fixed-convertibility, currency is bought and sold by the central bank or
monetary authority on a daily basis to achieve the target exchange rate. This target rate may
be a fixed level or a fixed band within which the exchange rate may fluctuate until the
monetary authority intervenes to buy or sell as necessary to maintain the exchange rate
within the band. (In this case, the fixed exchange rate with a fixed level can be seen as a
special case of the fixed exchange rate with bands where the bands are set to zero.)
Under a system of fixed exchange rates maintained by a currency board every unit of local
currency must be backed by a unit of foreign currency (correcting for the exchange rate).

33. This ensures that the local monetary base does not inflate without being backed by hard
currency and eliminates any worries about a run on the local currency by those wishing to
convert the local currency to the hard (anchor) currency.
Under dollarisation, foreign currency (usually the US dollar, hence the term quot;dollarisationquot;)
is used freely as the medium of exchange either exclusively or in parallel with local
currency. This outcome can come about because the local population has lost all faith in the
local currency, or it may also be a policy of the government (usually to rein in inflation and
import credible monetary policy).
These policies often abdicate monetary policy to the foreign monetary authority or
government as monetary policy in the pegging nation must align with monetary policy in
the anchor nation to maintain the exchange rate. The degree to which local monetary policy
becomes dependent on the anchor nation depends on factors such as capital mobility,
openness, credit channels and other economic factors.
Mixed Policy
In practice a mixed policy approach is most like quot;inflation targetingquot;. However some
consideration is also given to other goals such as economic growth, unemployment and
asset bubbles. This type of policy was used by the Federal Reserve in 1998.
Monetary Policy Tools
The Central Bank attempts to achieve economic stability by varying the quantity of money
in circulation, the cost and availability of credit, and the composition of a country's national
debt. The Central Bank has three instruments available to it in order to implement
monetary policy:
 Open market operations/ Monetary Base
 Reserve requirements
 Discount Window
 Interest Rates
Open Market Operations/ Monetary Base
Monetary policy can be implemented by changing the size of the monetary base. This
directly changes the total amount of money circulating in the economy. A central bank can
use open market operations to change the monetary base. The central bank would buy/sell
bonds in exchange for hard currency. When the central bank disburses/collects this hard
currency payment, it alters the amount of currency in the economy, thus altering the
monetary base. The central bank can control the circulation of money through the buying
and selling of bonds.

34. If they want to reduce the amount of money circulating then they sell bonds (which are
actually pieces of paper) in return for currency/money. They are not allowed to withdraw
money. In return they get a really High Interest Rate on their money.
Reserve Requirements
Reserve requirements are a percentage of commercial banks', and other depository
institutions', demand deposit liabilities (i.e. chequing accounts) that must be kept on deposit
at the Central Bank as a requirement of Banking Regulations. Though seldom used, this
percentage may be changed by the Central Bank at any time, thereby affecting the money
supply and credit conditions.
If the reserve requirement percentage is increased, this would reduce the money supply by
requiring a larger percentage of the banks, and depository institutions, demand deposits to
be held by the Central Bank, thus taking them out of supply. As a result, an increase in
reserve requirements would increase interest rates, as less currency is available to
borrowers. This type of action is only performed occasionally as it affects money supply in
a major way. Altering reserve requirements is not merely a short-term corrective measure,
but a long-term shift in the money supply.
Discount Window
Discount Window is where the commercial banks, and other depository institutions, are
able to borrow reserves from the Central Bank at a discount rate. This rate is usually set
below short term market rates (T-bills). This enables the institutions to vary credit
conditions (i.e., the amount of money they have to loan out), there by affecting the money
supply. It is of note that the Discount Window is the only instrument which the Central
Banks do not have total control over.
By affecting the money supply, it is theorized, that monetary policy can establish ranges for
inflation, unemployment, interest rates, and economic growth. A stable financial
environment is created in which savings and investment can occur, allowing for the growth
of the economy as a whole.
Interest Rates
The contraction of the monetary supply can be achieved indirectly by increasing the
nominal interest rates. Monetary authorities in different nations have differing levels of
control of economy-wide interest rates. In the United States, the Federal Reserve can set
the discount rate, as well as achieve the desired Federal funds rate by open market
operations. This rate has significant effect on other market interest rates, but there is no
perfect relationship. In the United States open market operations are a relatively small part
of the total volume in the bond market.

35. In other nations, the monetary authority may be able to mandate specific interest rates on
loans, savings accounts or other financial assets. By raising the interest rate under its
control, a monetary authority can contract the money supply, because higher interest rates
encourage savings and discourage borrowing. Both of these effects reduce the size of the
money supply.
Currency Board
A currency board is a monetary arrangement which pegs the monetary base of a country to
that of an anchor nation. As such, it essentially operates as a hard fixed exchange rate,
whereby local currency in circulation is backed by foreign currency from the anchor nation
at a fixed rate. Thus, to grow the local monetary base an equivalent amount of foreign
currency must be held in reserves with the currency board. This limits the possibility for
the local monetary authority to inflate or pursue other objectives. The principal rationales
behind a currency board are three-fold:
 To import monetary credibility of the anchor nation
 To maintain a fixed exchange rate with the anchor nation
 To establish credibility with the exchange rate (the currency board arrangement is
the hardest form of fixed exchange rates outside of dollarisation).
In theory it is possible that a country may peg the local currency to more than one foreign
currency, although in practice this has never happened (and it would be a more complicated
to run than a simple single-currency currency board).
The currency board in question will no longer issue fiat money but instead will only issue a
set number of units of local currency for each unit of foreign currency it has in its vault.
The surplus on the balance of payments of that country is reflected by higher deposits local
banks hold at the central bank as well as (initially) higher deposits of the (net) exporting
firms at their local banks. The growth of the domestic money supply can now be coupled to
the additional deposits of the banks at the central bank that equals additional hard foreign
exchange reserves in the hands of the central bank. The virtue of this system is that
questions of currency stability no longer apply. The drawbacks are that the country no
longer has the ability to set monetary policy according to other domestic considerations,
and that the fixed exchange rate will, to a large extent, also fix a country's terms of trade,
irrespective of economic differences between it and its trading partners.
Hong Kong operates a currency board, as does Bulgaria. Estonia established a currency
board pegged to the Deutschmark in 1992 after gaining independence, and this policy is
seen as a mainstay of that country's subsequent economic success. Argentina abandoned its
currency board in January 2002 after a severe recession. This emphasised the fact that
currency boards are not irrevocable, and hence may be abandoned in the face of
speculation by foreign exchange traders.

36. Currency boards have advantages for small, open economies which would find independent
monetary policy difficult to sustain. They can also form a credible commitment to low
inflation.
A gold standard is a special case of a currency board where the value of the national
currency is linked to the value of gold instead of a foreign currency.
Classification of Tools of Monetary Policy
They are classified into
• Quantitative Methods
• Qualitative Methods
Quantitative Methods
They consist of those methods which physically affect the amount of credit creation in the
economy. They are as:
Changes in Bank Rate Policy or Rediscount Rate
The rate at which the central bank of the country gives loans to commercial banks is known
as Bank Rate or re-discount rate, In Pakistan; State Bank charges 10% as bank rate. By
changing such rate of interest, the central bank can influence the supply of money in the
country. To control inflation the central bank increases the rate of interest. The commercial
banks will also increase their rate of interest.
Accordingly, the loans will decrease, investment, output and prices will fall. In this way,
inflation will be controlled. Now, we assume that the country is facing deflation. To
remove deflation central bank will decrease the bank rate, the commercial banks will also
decrease the rate .In this way, and people will get more loans. Investment production,
employment and Prices will start rising up. Accordingly, deflation will be controlled.
Limitations:
But the success of the bank rate policy depends upon
The fact that how flexible is the economic system. How rapidly, there will be the
•
effect of bank rate on other variables of the economy, like prices, wages, Interest
and output, etc.
Commercial banks should abide by the instructions of the central bank. If the
•
central bank brings changes in the rate of interest, the commercial banks should
also change the rate of interest.

37. If commercial banks already have excess reserves then commercial banks will not
•
depend upon central bank. It this way, they will not care for changes in the rate of
interest from central bank.
If economic activity is flourishing or economy is having boom, then the business
•
class will be prepared to pay even higher rate of interest and inflation will not to be
controlled.
Open Market Operation
This is the second instrument of the monetary policy. Under this technique, the central
bank sells or purchases 'government securities. If the central bank finds that commercial
banks are providing excessive loans which are creating inflation. To remove the inflation,
the central bank sells the government securities. The commercial banks will purchase these
securities to earn interest against such securities. In this way, the resources of commercial
banks will go down. They will advance fewer loans. Accordingly, the inflation will be
controlled, if there is deflation in the economy. To control the deflation, the central bank
purchases the government securities. Then the monetary base of the commercial banks will
increase their loaning power will increase. As a result, investment will increase; income
and prices will go up.
Limitations
• The problem is that, in most of the countries the money market is not organized
where the securities could be sold or bought.
• The funds which are collected through sale of government securities should not be
spent on unproductive fields.
Changes in Reserve Requirements
Each commercial bank has to keep a certain proportion of its deposits in the form of
reserves just to meet the demands of the depositors. As in the case of Pakistan, each
commercial bank has to keep 30% of its deposits to meet the needs of its depositors. The
central bank can influence this reserve rate. If the central bank realizes that the commercial
banks are advancing excessive loans, it will increase the reserve requirements.
Accordingly, commercial banks could advance fewer loans. On the other hand, in deflation,
if the central bank reduces the reserve requirements, the commercial banks will be able to
advance' more loans. Hence, deflation could be removed.
Changes in Reserve Capital
In case of Pakistan, each commercial bank has to keep 5% of its deposit in the central bank.
By changing the reserve capital, a central bank can control the supply of money by
commercial banks.

38. When there is inflation in the economy. To remove this inflation, the central bank will
increase the reserve ratio. As a result, lending of commercial banks will fall. As a result the
supply of money will decrease.
On the other hand, if central bank decreases the 'reserve ratio, the commercial banks will be
having more funds to advance. Accordingly, the deflation could be controlled.
Changes in Marginal Requirements
Commercial banks do not give loans against leaves, rather they ask for pledges to make.
How much a person will have to pledge is settled by the central bank. This is given the
name of marginal requirement. The central bank can bring changes in the marginal
requirements. If there is inflation in the economy, the marginal requirements will increase.
In this way, people will get less loans. As a result, supply of money will decrease. During
deflation the marginal requirements are decreased. Hence people will get more loans from
the commercial banks. As a result supply of money will go up and deflation will be
controlled.
Credit Ceiling/Rationing of Credit
The central bank can issue directions that loans will be given to commercial banks up to a
certain limit. As a result, the commercial banks-will be careful in advancing loans to the
people. But this is a very strict method, hardly adopted by the central bank. Moreover, if
the commercial banks are having other sources to borrow, they will not bother for this
policy.
Qualitative Methods
Moral Suasion
It is concerned with just as a moral request by central bank to commercial banks that loans
should not be given for unproductive fields which create inflation. Loans should not be
given for speculative purposes and hoarding. But such like requests could be effective in
the developed countries.
Consumers Credit Control
This instrument is applied during inflation. If the central bank wants to control the supply
of money, it will issue directions to commercial banks that loans should not be advanced
for consumption purposes or for consumer durables because they create inflation.
Direct Action
The instrument of direct action is concerned with the policy of central bank against
commercial banks. It can refuse to give loans to commercial banks. The central bank will

39. not advance loan to commercial banks for the sectors which create inflation. Moreover, if
commercial banks do not follow the instructions of the central bank, It will refuse to lend
commercial banks
Publicity
The central bank of the country is the overall in charge of economic stability of the
country. Its aim is to protect the economy from inflation and deflation. For this purpose, it
analyses the whole economy. It keeps an eye over the activities of the commercial banks. If
the commercial banks are found advancing loans which create inflation, their activities will
be unhealthy for whole economy. The central bank can black list such banks. Thus to avoid
such bad reputation in' future, they will be careful in advancing loans.
Role of Monetary Policy
The central bank is the sole issuer of banknotes and bank reserves. That means it is the
monopoly supplier of the monetary base. By virtue of this monopoly, it can set the
conditions at which banks borrow from the central bank. Therefore it can also influence the
conditions at which banks trade with each other in the money market.
Short run- Monetary Policy Transmission Mechanism
In the short run, a change in money market interest rates induced by the central bank sets in
motion a number of mechanisms and actions by economic agents. Ultimately the change
will influence developments in economic variables such as output or prices. This process –
also known as the monetary policy transmission mechanism – is highly complex. While its
broad features are understood, there is no consensus on its detailed functioning.
Long-run Neutrality of Money
It is widely agreed that in the long run – after all adjustments in the economy have worked
through – a change in the quantity of money in the economy will be reflected in a change in
the general level of prices. But it will not induce permanent changes in real variables such
as real output or unemployment. This general principle, referred to as quot;the long-run
neutrality of moneyquot;, underlies all standard macroeconomic thinking. Real income or the
level of employment are, in the long term, essentially determined by real factors, such as
technology, population growth or the preferences of economic agents.
Inflation – a Monetary Phenomenon
In the long run a central bank can only contribute to raising the growth potential of the
economy by maintaining an environment of stable prices. It cannot enhance economic
growth by expanding the money supply or keeping short-term interest rates at a level
inconsistent with price stability. It can only influence the general level of prices.

40. Ultimately, inflation is a monetary phenomenon. Prolonged periods of high inflation are
typically associated with high monetary growth. While other factors (such as variations in
aggregate demand, technological changes or commodity price shocks) can influence price
developments over shorter horizons, over time their effects can be offset by a change in
monetary policy.
Goals of Monetary Policy
The long-term goals of monetary policy are to promote full employment, stable prices, and
moderate long-term interest rates. Most economists think price stability should be the
primary objective, since a stable level of prices is a key to sustained output and
employment, as well as to maintaining moderate long-term interest rates. Relatively
speaking, it is easier for central banks to control inflation (i.e., the continual rise in the
price level) than to influence employment directly; because the latter is affected by such
real factors as technology and consumer tastes. Moreover, historical evidence indicates a
strong positive correlation between inflation and the amount of money.
While the financial markets react quickly to changes in monetary policy, it generally takes
months or even years for such policy to affect employment and growth, and thus to reach
the Fed's long-term goals. The Fed, therefore, needs to be forward-looking and to make
timely policy adjustments based on forecasted as well as actual data on such variables as
wages and prices, inflation, unemployment, output growth, foreign trade, interest rates,
exchange rates, money and credit, conditions in the markets for bonds and stocks, and so
on.
Working of Monetary Policy in Banks
The Bank’s monetary policy objective is to deliver price stability – low inflation – and,
subject to that, to support the Government’s economic objectives including those for
growth and employment. Price stability is defined by the Government’s inflation target.
The remit recognises the role of price stability in achieving economic stability more
generally, and in providing the right conditions for sustainable growth in output and
employment. The Government's inflation target is announced each year by the Chancellor
of the Exchequer in the annual Budget statement.
The State Bank of Pakistan sets an interest rate at which it lends to financial institutions.
This interest rate then affects the whole range of interest rates set by commercial banks,
building societies and other institutions for their own savers and borrowers. It also tends to
affect the price of financial assets, such as bonds and shares, and the exchange rate, which
affect consumer and business demand in a variety of ways. Lowering or raising interest
rates affects spending in the economy.
A reduction in interest rates makes saving less attractive and borrowing more attractive,
which stimulates spending. Lower interest rates can affect consumers’ and firms’ cash-flow
– a fall in interest rates reduces the income from savings and the interest payments due on
loans. Borrowers tend to spend more of any extra money they have than lenders, so the net

41. effect of lower interest rates through this cash-flow channel is to encourage higher
spending in aggregate. The opposite occurs when interest rates are increased.
Lower interest rates can boost the prices of assets such as shares and houses. Higher house
prices enable existing home owners to extend their mortgages in order to finance higher
consumption. Higher share prices raise households’ wealth and can increase their
willingness to spend.
Changes in interest rates can also affect the exchange rate. Changes in spending feed
through into output and, in turn, into employment. That can affect wage costs by changing
the relative balance of demand and supply for workers. But it also influences wage
bargainers’ expectations of inflation – an important consideration for the eventual
settlement. The impact on output and wages feeds through to producers’ costs and prices,
and eventually consumer prices.
Some of these influences can work more quickly than others. And the overall effect of
monetary policy will be more rapid if it is credible. But, in general, there are time lags
before changes in interest rates affect spending and saving decisions, and longer still before
they affect consumer prices.
We cannot be precise about the size or timing of all these channels. But the maximum
effect on output is estimated to take up to about one year. And the maximum impact of a
change in interest rates on consumer price inflation takes up to about two years. So interest
rates have to be set based on judgments about what inflation might be – the outlook over
the coming few years – not what it is today.
Setting Interest Rates
As banker to the Government and the banks, the Bank is able to forecast fairly accurately
the pattern of money flows between the Government's accounts on one hand and the
commercial banks on the other, and acts on a daily basis to smooth out the imbalances
which arise. When more money flows from the banks to the Government than vice versa,
the banks' holdings of liquid assets are run down and the money market finds itself short of
funds. When more money flows the other way, the market can be in cash surplus. In
practice the pattern of Government and Bank operations usually results in a shortage of
cash in the market each day.
The Bank supplies the cash which the banking system as a whole needs to achieve balance
by the end of each settlement day. Because the Bank is the final provider of cash to the
system it can choose the interest rate at which it will provide these funds each day. The
interest rate at which the Bank supplies these funds is quickly passed throughout the
financial system, influencing interest rates for the whole economy. When the Bank changes
its dealing rate, the commercial banks change their own base rates from which deposit and
lending rates are calculated.
Monetary Policy Objectives in Pakistan

42. The principal objective of monetary policy is to maintain stability of price. The objective of
price stability refers to the general level of prices in the economy. It implies avoiding both
prolonged inflation and deflation. Price stability contributes to achieving high levels of
economic activity and employment by
• Improving the transparency of the price mechanism, under price stability people
can recognize changes in relative prices (i.e. prices between different goods),
without being confused by changes in the overall price level. This allows them to
make well-informed consumption and investment decisions and to allocate
resources more efficiently.
• Reducing inflation risk premier in interest rates (i.e. compensation creditors ask for
the risks associated with holding nominal assets). This reduces real interest rates
and increases incentives to invest.
• Avoiding unproductive activities to hedge against the negative impact of inflation
or deflation.
• Reducing distortions of inflation or deflation, which can exacerbate the
distortionary impact on economic behavior of tax and social security systems.
• Preventing an arbitrary redistribution of wealth and income as a result of
unexpected inflation or deflation.
Challenges to National Economy
All the serious challenges national economy is facing today like very wide budget and trade
deficits, galloping inflation, increase in the level of poverty, power outages, water
shortages, closure of industries, food insecurity, etc, has diverted our attention from
realizing the very serious challenge that we have overcome the serious challenges
confronting us and suggest how the new government can overcome these.
Macro Economic Balance
The rate of growth of the economy during the last three four years improved a bit, but was
modest when compared with the rate of growth of our neighbors, China and India. Another
feature of the growth phenomenon that needs to be looked into is the un-sustainability of
the growth rate. When the growth rate becomes a little respectable for two or three years,
prices start rising and almost immediately a clam our for a tight monetary policy starts.
The two situations warrant very different approaches. If inflation is of the demand pull type
then tightening the monetary policy will, through dampening demand bring prices down. If,
however, inflation is of the cost push type, then a tight monetary policy will make matters
worse. And that is what has been happening in Pakistan over the last few years. Monetary

43. policy has been used excessively to contain inflation, irrespective of whether it is of the
demand pull or cost push type.
Even if prices are rising due to hoarding, monetary policy has been used and advocated to
contain inflation. Such a tight monetary policy has resulted in reducing the rate of growth
of the economy, without reducing the rate of inflation.
What should the government do to contain inflation? First, it needs to determine whether
prices are rising as a result of demand pull factors or cost push factors. If prices are rising
due to demand pull factors then tightening the monetary policy will be an appropriate
policy. But if prices are raising due to cost push factors then we need to identify the factors
that are pushing up prices and find alternatives to these. The excessive use of monetary
policy to fix up every problem in the economy is hurting the economy.
Monopolies and cartels have played a major role in restricting output and escalating prices
in Pakistan. Most of the members of cartels are ministers and other influentials. It thus took
several years for the government to convert the Monopoly Control Authority (MCA) into
Competition Commission. The new government needs to make it effective, formulate a
competition policy and enforce it. Competition policy is the appropriate policy to deal with
the problems of monopolies, hoarding, excessive profit margins, etc.
Industrial Concentration and Economic Power in Pakistan
Study shows that several industries have very high concentration ratios and Herfindahl
Indices. And when there is collusion between these firms, it produces a monopoly situation,
with the concomitant reduction of output and increase in profit margins.
The Competition Commission needs to compute the Concentration Ratio and the
Herfindahl Index for each industry and determine their acceptable levels for each industry.
And if the concentration level in any industry exceeds the acceptable level, then the
Commission should ensure that through promotion of competition, industries are made to
conform to desirable behaviour and conduct.
Budget Deficit
The budget deficit for the first six months of FY07-08 was 3.6% of the GDP and the likely
figure for the 12 month period is expected in the range of 6% of the GDP. Most of this was
on account of increase in development expenditure in the run up to elections, energy
related subsidies and the inability of the government to increase and diversify the tax base.
The prime minister's decision to reduce the expenditure on the Prime Minister's House by
40% is a step in the right direction. Similarly, Shahbaz Sharif has announced 70%
reduction in the non-development expenditures of the Punjab Government. Other such
steps to reduce non development expenditure along with the Finance Minister's statement
of looking into the possibility of reducing the defence budget are steps in the right
direction.