Interest rates have started rising. Banks' weighted average lending rate on fresh lending in September shot up to 5.84 per cent from 5.05 per cent in June.
This increase of 79 basis points pushed up the average lending rate on total loans of the banking system to 6.55 per cent in September from 6.49 per cent in June.
The increase in the average lending rate on overall loans was much smaller than in the increase in fresh loans because fresh loans given in July-September 2004 made up a small portion of the total loans outstanding at end-September.
Banks' lending rates have moved up in response to a gradual tightening of the monetary policy by the State Bank to contain rising inflation. In July-September, the SBP raised the weighted average yields on three-month and six -month treasury bills by 125bps and 93bps to 2.95 per cent and 3 per cent respectively. It also raised the yield on one-year bills by 178bps to 2.97 per cent.
This had a direct impact on export refinance rate that is linked with the average yield on six-month bills. The export refinance rate rose by 100 basis points to 3 per cent in the first quarter pushing up the maximum markup on export financing by a similar margin to 4.5 per cent. (Banks keep 150bps spread over SBP's export refinance rate while pricing concessional export loans under the SBP's Export Finance Scheme).
The central bank's signals about tightening of the interest rates also had an impact on Karachi Interbank Offered Rate or KIBOR. Six-month KIBOR that benchmarks pricing of short term loans shot up to 3.94 per cent at end-September from 2.97 per cent at end-June, showing an increase of 97bps.
Heavy intervention by the central bank to lift the rupee also led to increase in KIBOR by reducing the liquidity in the interbank market. The central bank sold more than $900 million in July-September, mopping up from the market about Rs54 billion in the process.
Besides, a 25bps increase in six-month LIBOR had an impact on interbank interest rate indicators the world over. Karachi was no exception. Six-month LIBOR for dollar funds rose to 2.19 per cent at end-September from 1.94 per cent at end-June 2004.
To sum up, whether one looks at treasury bills rates, or export refinance rate or KIBOR or even banks' average lending rates, a rising trend in the interest rates is quite evident.
But this interest rate tightening is yet to serve the basic purpose of containing inflation. Year-on-year increase in consumer inflation that was at 8.45 per cent in June rather rose to 9 per cent in September. Is there a need for a faster upward adjustment in interest rates during this quarter?.
Realising the challenge, the central bank has stepped up the tightening of interest rates. It raised the average yields on three-month and six-month T-bills by 27bps and 19bps to 3.22 per cent and 3.19 per cent respectively in October 2004. It also raised the yield on one-year bills by 87bps to 3.84 per cent during last month.
And, on November 10, the central bank made another bold move to raise six-month T-bills rate by 54bps to 3.73 per cent. Chances are that it will also raise the average yields on three-month and one-year bills sharply later this month.
The pace with which the central bank has been raising T-bills rate suggests that average yields on three-month, six-month and one-year bills would be somewhere around 3.5 per cent, 4.5 per cent and 5.5 per cent respectively at the end of this quarter in December 2004.
In that case, the maximum markup on export loans would rise to 6 per cent for January 2005, when Pakistan's textile sector would be exposed to tough competition after the elimination of textile quotas. Textile millers in particular and all exporters in general must keep this possibility in mind while preparing themselves for the post-quota regime.
Even if the markup on export loans rises to 6 per cent sometime during January-March 2005, and not precisely from January, this would irk the exporters most who used to get very cheap export loans till May this year.
Between August 2003 and May 2004, the maximum markup on export loans remained at 3 per cent as the SBP kept the export refinance rate pegged at 1.5 per cent in the backdrop of historically low treasury bills rates.
Exporters in particular and all businessmen in general must also be prepared to see their financial cost rising during this quarter due to an almost certain increase in KIBOR as well as banks' average lending rates.
That KIBOR would move up much faster during this quarter than in the previous quarter is indicated by the fact that in October alone it shot up by 58bps to 4.52 per cent.
And within 10 days of November it accelerated by another 65bps to 5.17 per cent. Banks quote KIBOR in different tenures, the most notable being six-month and one-year because most of the KIBOR-based lending to their customers is made in these tenures.
All banks charge a few percentage points premium over KIBOR of the relevant tenure while pricing the loans. They charge 0.5-1 percentage points premiums while pricing loans for prime borrowers including top business houses, multinational companies and state-run enterprises. But they charge much higher premiums, upto 4-5 per cent from majority of borrowers on the plea that these borrowers have lower credit worthiness and pose greater risks.
Senior bankers say six-month KIBOR may easily reach near 6.5 per cent by the end of this quarter. So, from next year, a vast majority of the borrowers would have to pay upto 10.5-11.5 per cent interest on the loans obtained on KIBOR-based floating interest rates. Even, top borrowers would see their KIBOR-based borrowing rates shoot up to 7.0-7.5 per cent.
KIBOR may keep rising during this quarter, and perhaps in the next two quarters also, in response to further tightening of interest rates by the central bank and its frequent interventions to support the rupee. Bankers close to SBP say it has sold more than $450 million in the interbank market in October 2004 to lift the rupee, mopping up about Rs27 billion from the banking system.
This was in addition to regular draining of surplus liquidity through SBP's open market operations. From November onwards, the central bank would be sucking in at least Rs21-24 billion from the banking system by selling around $350-400 million to the banks for financing oil import bills of their clients.
In addition to this, it will have to drain out excess liquidity time and again to keep monetary expansion at a level where it does not fuel inflation further and weaken the rupee.
The State Bank may continue to support the rupee in one form or the other for months to come. The reason is that international oil prices are unlikely to fall to the levels where their impact on Pakistan's trade deficit becomes nominal, encouraging the SBP to stop selling dollars for oil imports.
On the other hand, since inflation is still much higher than desired the central bank will have to raise treasury bills rates further, thus pushing up the interest rates to new peaks.
The above analysis of the interest rates scenario suggests that banks' weighted average lending rates would also rise at a faster pace during this quarter than in the previous quarter. Senior bankers say that the weighted average lending rate on overall stock of loans that stood at 6.55 per cent at end-September may reach 7 per cent at end-December.
This seems a likely scenario also because of the fact that private sector credit demand has remained very strong in the first quarter and looks set to get stronger in the second quarter. All the banks combined lent Rs64 billion to the private sector in the first quarter, more than double their lending of Rs31.8 billion in a year-ago period.
Latest data released by the SBP show that the private sector credit expanded more rapidly in the first three weeks of October bringing the total credit off take between July 1-October 23, 2004 to Rs101 billion. During the comparable period of the last fiscal year, private sector credit off take was Rs61 billion.
