KARACHI, July 8: With the State Bank's discount rate unchanged at 7.5 per cent since November 2002, the dependence of banks on the central bank as the lender of the last resort has gradually reduced.
The reason is they have the opportunity to borrow overnight funds at much cheaper rates.
Data released by the State Bank shows that in nine months to March 2004, the banks resorted to Rs20.6 billion discounting from the SBP, down substantially from Rs612.1 billion during the same period of the last fiscal year.
When banks run short of cash to meet their day to day requirements they borrow money for up to three days from the SBP discount window against approved securities.
This is called discounting and the rate at which the central bank provides this facility is known as discount rate or repo rate. Normally, it also serves as anchor of monetary policy.
The SBP data (contained in its third quarterly report) shows that in July-September 2003, the banks did not turn to the SBP discount window at all, but in October-December 2003, they resorted to Rs10.9 billion. Again in January-March, they had to borrow Rs9.7 billion.
As compared to this, the banks had to borrow Rs144.1 billion through the SBP discount window in July-September 2002 (when the discount rate was nine per cent), Rs325.3 billion in October- December 2002 and Rs142.7 billion in January-March 2003.
The incidence of discounting falling in July-March 2003-04 to a fraction of what it had been during July-March 2002-03 shows that in the later period the banking system had a lot of surplus liquidity. But at the same time it also indicates that the SBP discount rate had become somewhat irrelevant.
The weighted average yield on benchmark six-month treasury bills was at 1.2 per cent in July 2003 and the SBP discount rate was 7.5 per cent. Or a huge gap of 6.3 percentage points existed between the two.
Central bankers insist that since the determinants of the SBP discount rate and treasury bills rates are different, one should not see a huge gap between the two as a sign of falling efficacy of the discount rate as the anchor of the monetary policy.
But the fact is that a huge spread between six-month bills and a high discount rate gets wider when the discount rate is matched with a more comparable rate i.e. overnight call rate in the money market.
It is common knowledge that overnight call rates are normally lower than the T-bills rates. Admitted, that the discount rate often also serves as a penal rate for the banks that fail to meet their daily cash requirements on their own and have to look upon the SBP for cushion.
But even in that case, the element of penalty should not override the primary objective of maintaining the status of discount rate as the anchor of the monetary policy. Most central banks around the globe do this.
That the SBP discount rate has remained pegged at 7.5 per cent for a very long time also poses a challenge for the SBP that seems set to tighten monetary policy during this fiscal year to contain rising inflation.
But if it raises the discount rate for this purpose that may be misinterpreted by the market as a sign that interest rates may move up too sharply. That is exactly not what the SBP wants to do. The central bank is due to release its July-December 2004 monetary policy statement later this month.
