Permanent liquidity shortage?

The State bank of Pakistan (SBP) like any other central bank manages daily liquidity in the market through open market operations (OMO). In days of excess liquidity, SBP mops up liquidity and in days of liquidity shortage, injects it. It is supposed to be short term mop up or injection to ensure equilibrium in the overall money market.

Usually, in the days of an IMF programme (or when the government is running expansionary fiscal policy), due to the limitation of borrowing directly from the central bank (or excess borrowing demand), the OMO injection shoots up. The reason is simple. Government borrowing is higher than liquidity in the market and SBP has to intervene to ensure ample supply. In the past during FY16-19, the OMO injection had largely remained in the range of Rs1 trillion -Rs2 trillion, before coming down in FY19 and FY20.

Lately, in FY21, the OMO injection is touching new highs. The all-time peak touched Rs2.85 trillion (18% of banking deposits) and currently it is standing at Rs2.4 trillion. In the start of May-21, the number was Rs1.7 trillion. The sudden spike in May is due to high seasonal cash demand. This usually happens during days of Ramadan and Eid, as the Currency in Circulation (CIC) usually moves up as well.

There is another reason for high OMO as government is picking up higher amounts than targets to build up cash buffer for providing liquidity for a big maturity of PIBs (Rs961bn) due in July. Once that is over, the liquidity position may improve. The liquidity shortage may come back to Rs1.6-1.7 trillion in a few weeks. That is about the short-term movement of liquidity. The point to ponder is that liquidity shortage is being consistently over Rs1 trillion and even after normalizing, it may hover around Rs1.5 trillion – 10 percent of deposits.

That is too high a number. This implies that a decent chunk is becoming permanent liquidity shortage. Such shortages create risks for future government auctions. The problem becomes bigger when the market builds expectation of rate tightening and participants would like to wait for rate to increase before investing. Or the rates move up prematurely. That tells us a bit about steep yield curve, though due to better economic pick and posturing of the new FM, the yield curve has flattened a bit lately. However, it is still too steep.

Fortunately, there is a solution to the problem. According to SBP Act Section 18, SBP can go outright buying of government securities from the market. It should give a signal to the market that it may buy Rs100-200 billion every month to improve the liquidity position in the market and that may help flatten the yield curve further.

Having said that, SBP and MoF should work on solving the bigger problem i.e., growing CIC – it reached Rs6.5 trillion and has more than doubled in the last five years. It is standing at 42 percent of bank deposits as compared to 34 percent five years ago. That is primarily creating a liquidity shortage. Shaukat Tarin needs to bring back the confidence of people back into the banking system. Till that time, SBP should take required steps to bring sanity in the liquidity market.