The combined effect of falling foreign exchange reserves, along with strong credit demand, and seasonal factors has caused liquidity shortages in the banking system, says the State Bank of Pakistan. External sector developments have resulted in excessive drain of rupee liquidity from the system by Rs 92.7 billion during 1st July to 1st November FY096.
The net foreign assets (NFA) of the banking system have contracted by Rs 327.3 billion during this period. Despite pre-emption of SBP resources by the government, the strong demand for credit from both the Public Sector Enterprises (PSEs) and the private sector has further tightened the liquidity conditions.
Credit requirement of PSEs has increased enormously (Rs 62.8 billion during 1st July to 1st November FY09) mostly due to the issue of circular debt among the PSEs and the oil companies, while the demand for credit from the private sector has also increased sharply (Rs 125.6 billion during 1st July to 1st November FY09, as opposed to an expansion of Rs 60.5 billion during the corresponding period last year).
The increase in the latter is probably due to the beginning of the credit cycle and may also be a reflection of: one, companies are hoarding cash in light of the liquidity concerns; and two, the risk that this credit is being used in speculative activities."
More troubling, says SBP, is the market expectations that the government is planning to pull out the public sector/government deposits from the commercial banks, which is causing further anxiety in the market from the liquidity perspective. Adding to the pressures of the market liquidity conditions is the conversion of deposits into cash.
During 1st July to 1st November FY09, there was a sharp reduction of Rs 224.7 billion in total deposits of the banking system and an increase of Rs 170.9 billion in currency in circulation.
These trends in banking system liquidity partly reflect seasonality, as the currency in circulation normally increases around the Eid festival, putting temporary pressure on interbank liquidity. Also, liquidity constraints vary by bank--being steeper for banks with weak deposit mobilisation and relatively higher withdrawals.
OVERNIGHT CALL RATES: The liquidity constraint in the system has resulted in a rising trend in ''''overnight call rates'''' and reduction in excess liquidity held by banks over and above the required amount. In addition, the lack of liquid assets eligible as collateral for borrowing under Open Market Operations (OMOs)/discounting with some banks shot up the call rate to abnormally high levels.
Initially, said SBP, the banks met liquidity requirements by reducing excess reserves maintained with the SBP in the form of government securities. As a result, the excess liquid assets (mainly T-bills) with the banks declined to the lowest level of 2.2 percent of the time and demand liabilities (TDL) by 11th October 2008. These have now improved to 6.7 percent of TDL by 1st November 2008.
Reduction in T-bill stock has limited banks'''' ability to access the discount window and participate in OMOs, forcing them to borrow funds from the call interbank market. Consequently, the activity in the call market increased relative to the repo market and the overnight call rates rose to as high as 45 percent during the period from 4th-11th October 2008, resulting in the widening of liquidity spread in the overnight market.
Similarly, KIBOR of all tenors have been rising consistently over the past three months. For example, the 6-month KIBOR had reached 15.76 percent on 11th November 2008. SBP has been closely monitoring these developments in monetary aggregates and the interbank liquidity position.
Acting proactively, SBP made a net injection of Rs 272 billion in the system through 35 OMOs, conducted during 1st August to 11th November, FY09. In addition, banks have been allowed effective and liberal access to the discount window that resulted in availing of Rs 387 billion during this period.
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