Unexpectedly and shockingly, the government accepted too high bids in recent (26th Dec) fixed PIBs' auction. It was suggested that the government should not participate in the auction during days of rising interest rates (for details read "Debt profiling: don't repeat 2014 mistakes" published on 24th December, 2018). However, the government went ahead with it.
Either the government does not have a sense of market signaling or it was a pre-condition of the IMF to discover the yield curve. Since the government has not accepted a huge amount (Rs16 billion versus targeted Rs150bn), it is probably a condition of IMF which may result in higher debt servicing cost in years to come.
Pakistan’s domestic public debt (Rs18.9 trillion) is 3.5 times of the private sector credit and any change in interest rates have much pronounced implication of the domestic debt servicing. The government is using a foam of monetary policy to put out the fiscal policy fire. The problem is that the fire would mainly feed on the foam in the shape of higher debt servicing.
One may argue that since the government has just accepted mere Rs16 billion, as such the incremental fiscal impact is minimal. That may be true, but now individuals and companies employee fund can invest in NSS where the returns are going to be mouthwatering. The NSS rates are linked to PIBs cut off yield with a lag. The last PIB bid that was accepted in Jun18 was at 8.7 percent for 10-year paper; and within six months, in Dec18, the government accepted bids at 13.15 percent - a massive 445 bps point jump.
Now there is an arbitrage opportunity for individuals to buy NSS instruments at lucrative rates and pledge these to borrow from banks at lower rates. The NSS instrument will be locked in for the duration of maturity while the bank borrowing cost may decline by end of 2019 when interest rates start moving down.
It's time for smart people to make good bucks at the cost of the government. This happened in FY15 (Jul14-Jun15) when the rates peaked during Jul-Nov14, and this may happen now. The NSS flows (minus Prize bonds) were Rs261 billion in FY15 versus Rs149 billion in FY13 and annual average of Rs106 billion during FY16-18.
The problem is that the government has given the wrong signal to the market and the yield curve has further steepened as the long term papers spread are relatively higher than short term, adjusting to maturity. That is an unusual happening, as generally in rising interest rates environment, the short term papers are priced higher while the long term papers are less steep as market expects interest rates to come down.
This is what happens when government lacks capacity. There is no DG debt at Ministry of Finance and the economy at large is going to pay huge fiscal cost for it. If the ministry does not have the capacity, why does it not leave the interest rates setting to SBP?
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