Withdrawal of discount facility

The discount facility from the central bank is available to the financial institutions to meet their temporary needs for cash, squaring their positions or for other requirements at a predetermined rate which is adjusted periodically for easing or tightening of monetary stance.
Such a facility, known as "three-day repo", in Pakistan was available to the commercial banks and primary dealers from the State Bank. However, its ambit was extended on 31st January, 2002 when the SBP also allowed this facility to the Development Financial Institutions (DFIs) and investment banks on same terms and conditions as those for the commercial banks.
In a move unexpected by the market, the State Bank reversed this decision on 6th July, 2007 when it again barred DFIs and investment banks from availing its discount window facility, stating that three-day repo would, henceforth, be only available to the commercial banks and primary dealers. However, they were not stopped from investing in short-term government paper like treasury bills though, in the absence of discount facility, it would be difficult for them to take short-term positions.
The decision to exclude DFIs and investment banks from approaching the discount window of the SBP is not difficult to understand. These institutions were provided this facility when the rate of inflation was very low in the country and the growth momentum had to be accelerated by injecting more liquidity in the economy. Now, the monetary authorities are facing an entirely different challenge.
The inflationary tendencies in the economy continue to persist despite tightening of monetary policy by the State Bank in the recent past and the rate of inflation is expected to be substantially higher than the target of 6.5 percent during 2006-07. During FY08, the inflation target has again been fixed at 6.5 percent which could only be achieved by controlling excess liquidity in the economy and the present move of the State Bank is one small measure in that direction.
Since DFIs and investment banks will no more be eligible to avail the discount facility of the State Bank with effect from 7th July, they have to borrow from commercial banks to cover their short-term positions. This would curtail the credit creating capacity of the financial sector and push up the interest rates to a certain extent though it is hard to quantify the overall net impact of the measure at this point in time.
We feel that this would be a small step to reduce injection of liquidity in the economy and restrain reserve money growth and, as such, may have only a marginal impact on prices. It is hoped that the State Bank would keep a constant watch on the emerging inflationary situation and would not hesitate to take further monetary tightening measures if the rise in prices is not anticipated to be contained within the stipulated limits during 2007-08.