Pakistan’s central bank has kept its policy rate unchanged at 6.5 percent, thereby maintaining its accommodative monetary policy stance for the next two months.
This ‘wait and see’ attitude is based on some sound reasons. Banks on the other hand are making heavy investment in government papers and trades on the secondary market have resulted in an improvement in their yields in the short-term.
And, banks continue to make handsome profits on their PIB holdings (held to maturity portfolios) as well and their advance to deposit ratio (ADR) keeps on declining despite a cut of 300 basis points in the SBP policy rate since November 2014 onwards.
Even a raise in the recent budget in applicable tax rate plus a four percent super tax is of no consequence. If the return on equity (ROE) is good, their shareholders are happy; their investment in government paper is inching up because the federal government appears to be in a bind, ie, on a borrowing binge due to its continuous failure to achieve revenue targets.
Economists feel a massive further cut, say of 100 basis points, would encourage bankers to work harder and lend to the productive sector of economy instead of pouring their deposits in zero-risk assets. Bankers on the other hand do not want to take more risks in an area – other than power sector – where long-term credit does not make sense to them.
However, their credit to the energy sector alone is now more than the allocation to one sector – which despite sovereign guarantee for repayment cover is itself not timely serviced.
There appears to be, however, a serious lack of co-ordination between the monetary (SBP) and fiscal (Ministry of Finance) officials on what needs to be done in fixing the cut-off in the auction for government papers.
Initially, when the auction for T-bills and long-term bonds commenced SBP used to determine the cut-off and MoF merely announced the target for the auction – which was rarely adhered to. SBP has the knowledge of the liquidity in the banking system, whereas MoF is aware of the money needs of the government. Over the years, a debt management office was created in the Ministry of Finance.
The cut-off powers in the weekly auction were also transferred to finance ministry. And SBP now has only an advisory role. However, there appears to be a serious lack of co-ordination between the two arms that has resulted in acquisition of more expensive debt by the government, which now consumes 40 percent of the revenue.
Furthermore, governmental debt has reached a level that is in breach of the Debt Limitation Act 2002. Since risk-free government bonds are the only game in town, therefore government should be in a position to dictate the rate which it can only do if it has a better idea of the liquidity available and its needs.
Since banks know that government does not have the money to pay them and can only roll over the maturities of existing debt and it needs to incrementally borrow more at every auction they push for better yields. Treasuries in banks also know that the government has to retire SBP borrowings at the end of every quarter because of the terms agreed with the IMF.
Perhaps, in the mid-quarter, a couple of auctions need to be scrapped to jolt the bankers out of their complacency as they do not have any place else to park their liquidity (deposits) for profits. This approach may bring the cut-off closer to the target rate of SBP than to the ceiling rate in the corridor.
It needs to be observed that the SBP corridor is asymmetrical. And, the target rate is not at the mid-point of the corridor, which has five percent as the floor and seven percent as the ceiling. This is indicative of the thinness of the forex market in the country.
SBP has been cutting its rate in the hope that it would help spur economic growth as SBP feels that economy has stabilised. Has it? Yes, it has. It has stabilised with the help of debt creating flows instead of non-debt creating flows. Without sell-off of loss-making units, which need to be restructured and a template is created prior to privatisation with a guarantee for fresh investment by the private sector buyers, the growth objective will remain illusive.