Finally, the Monetary Policy Committee (MPC) has decided that it will not be having its regular meeting in July. In this calendar year, markets have witnessed five Rate cuts of which three were emergency cuts.
This is quite normal as per global norms. Recent history suggests that the US FED has made as many as seven emergency cuts. Prior to the latest FED emergency rate cut, the first cut was in October 1998 due to Russia and Long-Term Capital Management (LTCM) collapse, it slashed rates by 25bps, the dot-com bubble in 2000 saw a 50bps cut. Another 50bps was witnessed in the 2nd quarter of 2001. 9/11 forced a 50bps cut.
In August 2007, the Subprime mortgage crisis was a good enough reason for Fed to cut its rate by 50bps. January 2008, stock market forced the US central bank to go for a bigger chop by slashing its rate by 75bps and in the same year in September, the Lehman Brothers collapse compelled the Fed to act quickly by cutting its interest rate by another 50bp.
In March 2020, to combat the risk of pandemic Fed took emergency measures to slash its rate by 50bps, which was the 1st cut since the 2008 financial crisis. Other central banks in the footsteps of the Fed aggressively.
To contain the damage caused by Covid pandemic and rescue the economy, SBP has so far slashed the discount rate on five occasions by 625bps since March. Based on inflation data, two of those cuts were on the cards, but three cuts were surprising.
Interestingly, it is worth noting that the Monetary Policy Committee (MPC) meets six times a calendar or a fiscal year. There are two more MPC gatherings due in September and in November in the calendar year while five more in the current fiscal year. Globally, due to abnormal market/economic conditions, such actions are considered the new normal.
Lowering the SBP policy rate to 7 pct will reduce the cost of borrowing and with subsidy incentive, housing loans could become cheaper and may attract few buyers, but it will not prop up the economy. Take the example of the US where despite trillions of USD injection, the economy is on the declining trend and it could be headed for a negative interest rate, which means rate below zero and may add further liquidity to stimulate the economy. After the March injection, the size of the Fed balance sheet has jumped from $ 4.24 trillion to USD 7.095 trillion.
Japan decided to go for negative rate in 1999; it still has a negative rate. Its economy mildly bumped up for a few years before again entering the deflationary zone; it is suffering since 2016. Europe also has a negative deposit rate.
Last year, two Nordic banks in Denmark and Finland experimented by offering 10-year loans at minus 0.5% and 20-year mortgage loans at zero percent, respectively. The cuts are meant to boost demand and money supply in the economy.
Negative interest or lower interest rates have yielded mixed results. Theoretically, it should boost the economy that encourages customers and banks to take both risks (borrowing/lending). But in our case this is not possible unless ample liquidity is released.
July inflation figures may end up around 8.85% due to mismanagement and administrative weaknesses. It may start easing in the following months and should not bother monetary managers, as food and oil prices should give comfort. The drop in proportion of trade numbers clearly indicates that inflation is not demand driven.
When credit is taken for reduction in current account and managing balance of payment (BOP) position, then obviously revenues will take the hit. The best way to counter-check the activity is the surprising surge in the stock of deposit of schedule banks by Rs 1.75 trillion in 2 months to Rs 16.23 trillion, which could be a combination of bank profit, interest accrual, remittances and financing injection. While in the same period the stock of bank advances has dropped by Rs 14 billion to Rs 8.20 trillion. This reveals an alarming drop in Bank Deposits to Advances Ratio to 50.52% which is a clear hint that the economy is underperforming. Credit to the private sector is negative Rs 84 trillion. Despite Covid-19 and lockdown, currency in circulation has skyrocketed to Rs 6.318 trillion.
Surprisingly, if we take a look at the SBP numbers released on the website, economic activity does not match the data and is still too low, despite the funding received from donors for financing and nearly Rs 140 billion cash distributed though Ehsaas programme, it does not match the figures.
Economy will continue to struggle, as long as SBP offers liquidity through its Open Market Operations (OMOs). The only solution to all the problems can be found by squaring the SBP OMO book to zero and by keeping the market liquid. Simultaneously, to engage the economy to play its role, cut rates by another 150-200bps and widen the interest rate corridor overnight repo (floor) rate by 250 to 300bps below the SBP policy rate. Chop Statutory Liquidity Requirement (SLR) and Cash Reserve Requirements (CRR) by 2- to 3% and inform the government that they are unable to play its role due to severe breach of the Fiscal Responsibility and Debt Limitation Act. Also inform them that SBP is already providing rupee and foreign currency liquidity through derivatives.
The central bank should ask the finance ministry to assist in putting a cap on investments in government paper by commercial banks, which should not exceed 33%. It will help in generating liquidity of roughly around Rs 2 trillion.
(The writer is former Country Treasurer of Chase Manhattan Bank)
Copyright Business Recorder, 2020
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