Liquidity matters

Liquidity is short in the market! The factors behind this could be higher cash withdrawal for Eid spending, tax imposed on banking transactions by non-filers, and increased reliance of fiscal borrowing from scheduled banks. It has to be the combination of all but due to paucity of data it’s hard to pinpoint the exact reasons of it.
Whatever it is, last week SBP injected Rs1.048 trillion through OMO for 14 days at the rate ranging from 6.37 to 6.75 percent. This is the second time in this calendar year when the OMO injection crossed trillion rupee marks. The liquidity injections by central bank to scheduled banks have significantly increased since February 15 and most of the money is continuously rolling over with Rs600-700 billion effectively remaining injected all the time.
This implies that the Eid affect is marginal and the liquidity shortage issue has rather been prevailing for months now. This is evident from the fact that currency in circulation has increased substantially in FY15 (up till 26th June) to Rs400 billion – exhibiting an increase of 54 percent from the corresponding period last year.
This is a point of concern for policymakers who are envisaging enhancing the documentation and working on increasing financial inclusion. The numbers are suggesting that outcome of these policies might be counterproductive. The fiscal authorities in FY14 had increased the WHT/advance income tax on non-filers from what is being levied to those who file returns- such as 0.5 percent tax on cash withdrawals of over Rs50,000 from banks on non-filers, while for filers it was 0.3 percent.
In order to avoid this tax, people might have taken money out from the checking and saving accounts. Anecdotal evidence suggests that many traders and shopkeepers are keeping cash in bank lockers or at other safe places. The government has further widened the gap between filers and non-filers in FY16 budget, and has imposed tax on all banking transaction while it was only at cash withdrawal in the previous year.
Initially the tax was at 0.6 percent but after the hue and cry of trader community the rate has been slashed to 0.3 percent for three months and it will be reviewed by September. The number of currency in circulation for the first two weeks of July is not published yet but chances of higher withdrawal are high. And it’s safe to assume more money will go out of the system in FY16 to further stress the liquidity situation.
When the liquidity is short, banks go to the SBP for cash and the central bank either prints money or injects through open market operations. Since there is a strict condition by IMF on printing money and SBP is adhering to it, the only option left is to keep on pumping more and more liquidity into the system.
Banks don’t mind it. They have locked Rs2.5 trillion in PIBs at higher rate (12%+) and for the shortage of liquidity they keep on getting money from SBP at discounted rates. The prevailing OMO rates are around 6.5percent which is the half of what banks are milking on PIBs.
OMO injections will keep on rolling over as government borrowing from scheduled banks is increasing – the government may need to borrow well over a trillion rupees in FY16 from banks and SBP indirectly will provide that money through OMO injections as the PIBs maturity will start come July 2016.
In FY15 (till 26th June) the government borrowed Rs1.2 trillion from scheduled banks as compared to Rs104 billion in the corresponding period last year. What triggered this increase at the time of trimming fiscal deficit? The foremost factor is shift of fiscal financing from the central bank to commercial banks as the government’s borrowing from SBP is negative Rs228 billion in FY15 as compared to Rs246 billion in the similar period last year.
This implies that the government retired almost Rs474 billion of central bank debt in FY16 and that onus has fully shifted to the commercial banks. Then the foreign component of fiscal financing might have reduced as well in FY15 as the Net foreign assets flow is two third of what it was in the previous year – down from Rs333 billion to Rs221 billion.
The three factors – government borrowing from scheduled banks, low NFA growth and high CIC have shrunk the pie for private sector - credit to private sector is down by 57 percent to Rs164 billion in FY15. That is not a good sign for an economy in search of growth and employment generation.
A more worrisome fact is deteriorating NFA to NDA ratio which is down from 0.49 (FY14) to 0.22 (FY15) – higher the ratio lower is the inflation. And the main culprit is the surge in the net domestic assets and main contributor to high NDA is government borrowing from scheduled banks which is ballooned due to continuous high OMO injection. In a nutshell, the ongoing rolling over of OMO injection might be as inflationary as note printing and downside to it is crowding out of private investment and undue profits of commercial banks.