The Jahangir Siddiqui PGBI, which is the primary indicator of Pakistan Bond Markets, showed a decrease of 1.4828 points over the week, bringing the index value to 90.2583 with a weighted index yield of 9.1520 percent on April 30, 2005. The Jahangir Siddiqui PGBI has shown an overall decrease of 9.7417 percent since its inception on July 1, 2004, and a fall of 8.3793 percent since December 31, 2004. This was another volatile week for bond yields. The 10-year benchmark PIB yield rose continuously over the week, setting highs, last seen 3 years ago. The 10-year PIB yield, as of last Saturday, was 9.32 percent.
Salman Jafri at JS Capital Markets, in a report, said that the increases in yields had come mostly from the market''s adjustment to a new interest rate regime as the SBP moved to tighten money supply. Three-year and 5-year instruments saw very little trading over the past month as demand for these instruments all but disappeared due to the increases in short and medium term deposit rates. The last 3-month T-bill cut-off yield was approximately 0.39 percent above the coupon on the latest 3-Year PIB.
The money market remained liquid during the week. The SBP conducted an auction of 6-month Treasury Bills. The pre-auction target was Rs 20 billion, and bids of Rs 20 billion were received from the Primary Dealers. The SBP picked up Rs 8.16 billion at 7.1877 percent cut-off yield and rejected the remaining bids.
The SBP then conducted an OMO the next day in which it offered to pick up money for 4 weeks in repo. In this OMO, the SBP also indicated that it wished to sell 6-month Treasury Bills outright as well. This action surprised the market and resulted in a negative impact on bond prices and brought yields further upward. The SBP rejected bids for the 6-month T-bill in the OMO but picked up Rs 17.25 billion in 4 weeks OMO at 6.75 percent.
When central banks move to tighten monetary policy they have three main tools available: 1) Open Market Operation (OMO), 2) The Discount Rate, and 3) The Statutory Reserve Ratio. "Of these tools we have already seen SBP use the Discount Rate and the OMO with the intention of bringing the interest rates up and tightening money supply." The Statutory Reserve Ratio is the percentage of depositors '' money that banks keep with the SBP as reserve money. Increasing this ratio chokes off money supply precisely at the root. The market expects this tool to be brought into operation in the near future. The consequent impact will be an upward move in interest rates.
As of last week of March 2005 total customer deposits of scheduled banks were 2.248 trillion rupees. An increase of 1 percent in the Reserve Ratio will have an impact of Rs 22.248 billion.
Since every rupee in the system circulates multiple times, the actual impact will be much greater in rupee terms.
The fixed income markets have been resisting rate increases continuously over the past two years. "Using the 10-year as a benchmark we saw the market resisting an increase above the 6 percent level." The second resistance came at 6.5 percent as banks fought to protect PIB and fixed rate investments from price deterioration.
These were two major resistance points at which banks built up large inventories of PIBs with the view that rates would fall in the future. Rising inflation, however, threw a spanner in the works and bond yields spiralled upward. The last major resistance point was the level of 8.5 percent. The 10-year yield sliced through 8.5 percent, 9.0 percent and 9.5 percent like a hot knife through butter.
It should also be noted that there has been no issuance of PIBs since May 29, 2004, because all auctions held since then have been rejected. The 10-year PIB yield has effectively gone up 2.42 percent (last cut-off 7.36 percent versus current yield of 9.78 percent) over the past year without any supply from the government. If the government at this stage indicates any further supply it would result in a faster increase in yields across the board.
An informal poll of the market revealed that there was almost no corporate sector demand for PIBs, at the moment, because of reasonable rates available in bank deposits and floating rate TFCs. Bearish sentiment prevailed on expectations of an increase in Reserve Ratios and a further hike in the Discount Rate, earliest by June and latest by December 2005.
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