Despite injection of liquidity through reverse repo, not allowing the market to borrow at lower than cost, and by raising its cut-off yield, the SBP''s intention seems quite obvious.
It worries about inflation and does not want to risk leaving enough liquidity in the market, unless it has the evidence that the economy is not heating up anymore.
Last injection was seen on Saturday, April 22, when the central bank injected Rs 14 billion at 8.72 percent, but liquidity crunch persists in the interbank market. The central bank did not succumb to the market demand to lower its purchase of T/bills.
Latest SBP data suggest that the private sector credit soared to Rs 353 billion, against FY06 target of Rs 330 billion, and there are still two more months to go, which also indicates that there could be a repeat of last fiscal year''s credit number for the second successive year.
Though April''s inflation data may once again show a drop in the inflation, this would be due to point-to-point measuring, which would be misleading due to a higher base for the preceding year. This may not reflect the true picture. SBP, it seems, wants to wait for more evidence, as it fears that the real impact could be otherwise in the coming months.
Another factor that has more to do with the liquidity crunch is ambitious overbidding for Treasury bills by banks in the last two auctions rather than any inflationary concern. Banks in their bidding tested the SBP''s resolve for T/bills.
The central bank was not willing to send a wrong signal by lowering the yield or leaving any surplus liquidity in the market. Against an auction target of Rs 2 billion, the banks offered Rs 14.65 billion at last cut-off yield of 8.7907 percent, anticipating an easing of the yield due to softer March inflation data, that was 6.9 percent, though there is no indication of major Rupee inflow in April or May.
The Chief dealer of a private commercial bank says: "The Rupee market is too tight, with no sign of inflow of funds, and the current borrowing cost is very high. Since SBP is lending money at a very high price, the bidding in three-month and six-month is not attractive. Interest in 12-month may see the last cut-off yield for a small amount."
Meanwhile, foreign exchange dealers have confirmed that the SBP had not been seen in the interbank FX market doing buy/sell swaps since last month. SBP''s latest website update of its International Reserves and Foreign Currency liquidity position as of March 31 shows outstanding swap figure of $235 million.
FX dealers are of the view that SBP does not carry forward anymore swap outstanding position in its books and should square its long position. Dealers say that for the past few months the central bank had been doing only short dated swaps. Banks are comfortable in Nostro''s and forward premiums are gradually on the rise. This also indicates that the SBP has successfully retired its forward position.
The Interbank foreign exchange market has been demanding that SBP should dispense with the swap transactions, and let the market decide the real rate, based on interest rate differential. Though the country''s trade volume has doubled in a short span of time, the daily volumes in the interbank FX market, which was between $150 million to $200 million, fell to $75 to $100 in the last couple of years.
Estimates are that activity in the interbank market has once again regained its lost confidence. The SBP has recently extended swap trading cut-off time up to 1630 hours for interbank transactions. But it has not allowed banks to carry on with outright transactions after 1400 hours.
In May 2003, SBP was holding a plus $540 million position, but it has been carrying a perpetually negative swap position since April 30, 2004. In November 2004, SBP was carrying $590 million negative position, created by a Buy/Sell swap to show high foreign exchange reserves.
FX dealers say that allowing a wider Rupee/Dollar band has given both importers and exporters an ample opportunity to transact at a suitable price. Dealers also confirm increase in FX activity due to the widening band. On Tuesday, interbank FX market closed at 60.03/04.
FX forward premium is up due to liquidity crunch, as Rupee offers better return versus Dollar. One-month was dealt at 20 paisa, two-month traded at 38 paisa, three-month was at 55 paisa and six-month was at 104 paisa. In the absence of SBP from interbank FX swap market, dealers were targeting six-month for 120 to 130 paisa.
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