The State Bank's Financial Markets Review for 2003-04, issued on 1st December, 2004, is a well written story of last year's financial market developments relating particularly to the interest and exchange rate behaviour and its overall impact on the economy. Pakistan's financial markets, according to the Review, witnessed significant changes in FY04.
Interest rates saw a historic low, the rupee rose to a three-and-a-half year high and the capital market witnessed a new all-time peak, all other markets also saw improvements in depth and liquidity. In the money market, the average repo rates in FY04 were almost one half of those prevailing in the preceding year and the trading volumes were much higher.
Capital markets were buoyant as corporate earnings averaged 26.5 percent. Sixteen public offerings amounting to Rs 55.6 billion were floated and most of these were over-subscribed.
The investor base was expanded due to the government's policy of attracting small retail investors to the sale of shares by public sector companies. The share of market capitalisation in GDP also increased from 19.7 percent in FY03 to 26 percent in FY04. The mutual fund industry also witnessed a significant growth but despite this robust growth, this industry is still under-developed.
The rupee lost its value against most of the currencies. It depreciated by 0.5 percent against the greenback, 6.5 percent against euro, 10.1 percent against yen, 9.4 percent against pound sterling, 0.5 percent against Chinese yuan, 1.7 percent against Indian rupee and 3.2 percent against Thai baht.
The exchange rate in real terms also depreciated due mainly to the nominal depreciation of the rupee against US. dollar. Besides, inter-bank foreign exchange market witnessed a high level of activity in FY04. "The volatility in the money and foreign exchange markets posed a significant challenge to the SBP policy, as it sought to strike a balance between interest rate and exchange rate stability, containing inflation and sustaining the growth momentum".
The increased market volatility led to an increased focus on risk management by domestic financial and non-financial corporates. Another major development in FY04 was the increased integration of the money and forex markets, as the impact of intervention in one was clearly reflected in the other.
The Review also envisages that the increase in money supply will be kept below the rise in nominal GDP during FY05 and if inflationary pressures do not ease, it may be desirable for the SBP to further tighten its monetary stance.
The State Bank's staff, in our view, has done a good job of reviewing various developments in the financial sector and on the external front during FY04. The Review's focus on country's external account and shifting expectations on interest rates together with the elaboration of close inter-action between interest rate and exchange rate policy would undoubtedly add to its value.
How the central bank is expected to respond to the rapidly changing domestic and international environment in various sectors has been made quite clear in the write-up and this knowledge would be useful for the students and teachers belonging to the relevant fields.
The State Bank has also given a timely warning to the small banks that holding large amounts of PIBs in their books and a sharp reversal in interest rates could erode their capital base.
Although it may be quite tough for the State Bank to contain the increase in money supply below the nominal GDP growth during FY05 due to the rising demand for credit from the public and private sectors, the mere fact that it is prepared to follow such a course to reduce inflationary pressures in the economy is a matter of some satisfaction.
However, there is something puzzling about the appearance of the Review. What has been mentioned and explained in the Review could be categorised as a routine job of a central bank and there was hardly any need to cover such a regular activity in a separate document especially when the State Bank's high officials use various occasions to highlight these matters. In fact, judging from the pronouncements coming almost on a daily basis, the State Bank, compared to the other central banks, seems to be an over-exposed and over-publicised institution.
Also, the developments contained in the Review are mostly outdated and could have been easily covered in State Bank's annual report, which was released earlier.
It may also be mentioned that some institutions in the private sectors are doing a much better job of analysing and projecting the trends in the financial and capital markets. Obviously, they cannot be as accurate as the State Bank but their analysis for investors and other relevant agencies could be much more valuable for understanding the latest trends and adjusting their portfolios in time.