The T-bills auction conducted by the State Bank of Pakistan on 2nd August 2006, the first one after the increase in discount rate by 0.5 basis points to 9.5 percent, yielded interesting results.
There seemed to be a vast difference in the perception of the seller (the State Bank) and the buyers (Primary Dealers including commercial banks) about the direction of the money market and, as a result, the amount offered and accepted differed markedly from the target, and the actual increase allowed in the T-bill rates was almost half of the rise in the discount rate.
Total amount received for the purchase of T-bills was Rs 24.19 billion, as against the pre-auction target of Rs 38 billion, out of which only Rs 6.2 billion were accepted. Highest amount of Rs 5.93 billion was accepted for three-month paper and cut-off yield was raised by 31 basis points to 8.6417 percent.
For six months T-bills, the cut-off yield was up by 32 points and the amount accepted was Rs 239 million. Smallest amount of Rs 91 million was raised for 12-month bills and their cut-off yield was enhanced by 21 basis points to 9.0046 percent. Overall, the yield was increased in the range of 21-32 basis points which was the highest rise in more than half a year.
It transpires from the result of the auction that the State Bank and the bidders were probably not on the same wavelength. The hike in the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) by five percent with effect from 22nd July, 2006 followed by an increase of two percentage points in the discount rate a week later was understood by the money market players as a signal that rates on the government paper will also be raised commensurately.
As such, the amount offered by them was smaller than the target and at a higher rate. They also expected that the State Bank would be anxious to unload government securities held by it in the market in a short period of time in a bid to ease the inflationary pressure in the economy. However, the State Bank did not want to appear to be desperate and its policies to be dictated purely by the market sentiment.
It desires to move gradually and in a phased manner although upward adjustment in the interest rate structure is almost inevitable after the recent monetary tightening measures and the clear message in the Monetary Policy Statement (MPS) for July-December, 2006 that price stabilisation is now a priority for the central bank of the country.
As it is, the acceptance of Rs 6.4 billion in the auction would leave at least Rs 33 billion of liquidity in the system because of the T-bills maturity of Rs 39 billion which would reduce the call rate in the interbank market temporarily.
Hopefully, the surplus amount of liquidity would be drained by the central bank gradually, without causing disruption in the system and ensuring at the same time that the objective of monetary stability is achieved without hurting growth in a substantial manner.
However, a few aspects of the recent tightening of monetary policy need to be thought through and preferably discussed with the relevant players by the SBP's top officials without sacrificing the basic policy thrust of the central bank. For the present monetary policy stance to succeed without harming growth, it is imperative to mobilise a higher level of savings by offering a sufficient rate of returns on deposits so that more financial resources are available to meet various needs of the economy.
The recent initiatives of the State Bank would cause lending rates to rise further and the banks need to be advised to narrow the unprecedented spread by increasing the deposit rates substantially in order to mobilise more resources and achieve a sustainable growth. If moral suasion fails, the central bank could adopt unconventional methods. It could increase capital adequacy ratio, enhance provisioning requirements or even ask the government to again increase the tax rate on the banks' earnings to bring them in line.
The behaviour of the banks also needs to be watched carefully in the next few months for other reasons. At present, the increase in discount rate and other measures may not cause too much discomfort to the banks but the onset of busy season in September could cause certain problems related to the magnitude of financial resources at their disposal and its utilisation which would be crucial to the conduct of monetary policy.
Of course, the rise in the rate on government paper, including the T-bills, would mean higher debt servicing for the government but the net impact would depend on the type of holders of these assets. If a large part of these assets continues to be held by the State Bank, the net impact would be smaller since the profits of the State Bank are directly transferable to the government exchequer.
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