The economy is nose diving and it is time for banks to make merry in the PIBs bonanza. The IMF conditionality is creating an opportunity for banks and others to make windfall gains in the bond market at the expense of the government of Pakistan (read taxpayers).
The PIB auction is scheduled tomorrow, and the secondary market yield of to be issued bond is around 14 percent, and a cut off of 14 percent on 10 year PIB is very much on the cards. The IMF and SBP expect inflation to remain high in FY20 before tapering off in subsequent years. It will remain in double digits (estimates are from 11-13.5% average inflation) and to come down to single digit in following years.
Since the inflation is high in short term, the short terms rates should be high, and the long term rates should be low aligned to low inflation expectation in the long term. The yield curve should be flattish, if not inverted. But here, a steep upward yield curve is the case in peaking interest rates scenario.
The IMF to be condition is that every bid should be accepted, barring the outliers. This has been exercised in Egypt, and the bid acceptance of last two T-bill auctions at home demonstrated that very phenomenon. Otherwise, the debt office of MoF had a different thinking to bring the rates down in line with stability coming in. But it does not matter what debt office at MoF thinks, as the decision relies on IMF’s conditions and SBP’s will.
The central bank's team performance is gauged on the robustness of the banking sector. A combination of high profitability and low risk is the best option for banks and SBP team may support this. Having fixed rate PIB at peaking rates is free lunch - locked in for ten years, with capital gain or high profits to be had in low interest rates days, as good dessert.
This space is against the issuance of fixed rate PIBs. If government has to issue long term papers, for improving debt maturity profile, it should be done by issuing floating papers. The floating rates 10Y PIB were last issued at 70 bps over 6M T-bill which is making today's rate around 13.5 percent, while the fixed rate same tenure instrument is likely to have a cut off yield of 14 percent tomorrow.
Ideally, in peaking interest rate scenario, the rate of floater should be higher than the fixed as the former is to accommodate for higher short term rates and that to be adjusted every six months, while latter is locking for full term. What is happening is the exact opposite and absurd.
Now that it is happening, the focus should be allowing individuals the opportunities to buy. Any individual should be allowed to open IPS account with a primary dealer (a few banks) to bid at non competitive rate. That will make the individual buy PIB at cut off yield.
What banks would like to do is to sell it to individuals after having their cut which could be as high as a bank can charge an uninformed costumer. That is a double blow - government (tax payers) and individuals (mainly tax payers). This has to be stopped. Other option individuals have is to invest in NSS - for retirees and widows, Bahbood is the best option (limit is Rs5 million).
Anyone holding foreign currency at zero percent in anticipation of further rupee depreciation should rather convert into PKR and invest in PIBs or NSS or in commodities (gold) as returns on these, at today's level, could be higher than keeping cash in foreign currency. In simple words, dollar appreciation would be lower than returns in domestic bond market.
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