KARACHI, June 1: The State Bank’s decision to intensify tightening of interest rates in April led banks to increase their own lending rates by 20 basis points on an average. The weighted average lending rate of all the banks combined rose to 7.49 per cent at end-April 2005 from 7.29 per cent at end-March, data released by the State Bank show. On April 11, the central bank had increased its discount rate by one-and-a-half percentage points to nine per cent, intensifying an ongoing tightening of interest rates to contain inflation.
Between July 2004 and March 2005, when the SBP was engaged in less aggressive and gradual tightening of interest rates, the weighted average lending rate of the banks had recorded an average monthly increase of 9bps only. The average lending rate had risen to 7.29 per cent at end-March 2005 from 6.49 per cent at end-June 2004, showing an increase of 80bps.
A 20bps increase in the average lending rate in April means the rates will rise faster in the following months because this increase has come in response to an aggressive tightening of monetary policy in the last 20 days of April. Since the central bank has kept up that aggressive tightening and has allowed big increases in the yields on treasury bills last month also, the banks have started increasing their lending rates in the same fashion. “Data for May, which would be out at the end of this month or early next month, would definitely show a sharper rise in lending rates,” said head of treasury of a leading local bank.
During July-March 2004-05, the central bank used average yields on treasury bills as the prime indicator of its monetary policy while keeping discount rate unchanged at the November 2002 level of 7.5 per cent. During this period, it increased the weighted average yield of benchmark six-month bills by 3.1 percentage points to 5.18 per cent. But in April alone it increased the yield further by 2.64 percentage points to 7.82 per cent.
This suggests that the central bank became more aggressive in tightening of interest rates at the beginning of the fourth quarter after having observed that its gradual tightening had failed in checking inflation effectively in the first three quarters. Inflation showed an average annual increase of 9.06 per cent in the first three quarters of this fiscal year, i.e. July-March 2004-05. This rate of increase in inflation against the full year target of five per cent prompted the SBP to take a tougher stance on tightening of monetary policy.
Inflation is now estimated to close somewhere around 9.4-9.7 per cent at the end of the fiscal year in June if the SBP keeps up increasing interest rates faster than in the past — and the government takes practical steps to improve supply of food items and break monopolistic and speculative trends in businesses.
EXPORT FINANCE RATE: As the weighted average lending rate rose to 7.49 per cent in April, which is likely to rise further but remain below eight per cent, has provided a good justification for the central bank to defend its decision of capping export finance rate at eight per cent in June. The rate of export finance soared to eight per cent for May 2005 from 3.5 per cent in June 2004, showing an increase of 4.5 percentage points within 11 months of this fiscal year, as the central bank increased its refinance rate from two per cent to 6.5 per cent during this period. While pricing export finance, the banks are allowed to charge a premium of 1.5 percentage points over the SBP export refinance rate.
The central bank fixes the export refinance rate for the next month keeping in view the weighted average yield on six-month T-bills in the previous month. Since the average yield on six-month bills had shot up to 7.82 per cent in the last auction held in May, theoretically the SBP should have raised the export refinance rate to at least 7.5 per cent, thus allowing the export finance rate to move up to nine per cent.
But the SBP did not do this not only to avoid criticism from exporters who are battling to grab a larger share in the quota-free textiles market, but also because the export finance rate of eight per cent was already higher than the weighted average lending rate of 7.49 per cent.
