August 27, 2007	Monday	Sha’aban 13, 1428

On August 21 the State Bank of Pakistan increased the cut-off yields on long-term Pakistan Investment Bonds signalling that it would employ every tool to tighten the monetary policy. Earlier it had raised its policy rate by half a percentage point to 10 per cent on August 1.

And on August 24, a day after the Supreme Court decision allowing former Prime Minister Nawaz Sharif and his brother Shahbaz Sharif to return home, the rupee lost eight paisa against the dollar.

In PIB auction, the central bank increased the maximum yield on the benchmark 10-year bonds by 23 basis points to 10.35 per cent. It also spiked the cut-off yield on 15-year and 20-year bonds to 11.15 and 11.40 per cent respectively. Earlier the highest yields on these bonds stood at 10.98 and 11.20 per cent. The SBP also reset the cut-off yield on 30-year bonds at 11.68 per cent up from 11.59 per cent.

“Banks and large corporates had already anticipated an increase in PIB yields and the new cut-offs were close to what they were expecting,” said treasurer of a local bank. Money market dealers said that State Life Insurance Corporation bought 15, 20 and 30-year PIBs worth about Rs5-8 billion by way of pass-through bids in the auction. In total the central bank sold Rs15 billion worth of PIBs of different maturities.

In three days following the auction, some other corporates also bought PIBs from the secondary market, as fresh high yields on the bonds became quite attractive.

In the auction, banks mostly purchased PIBs of three-year, five –year and 10-year.

The dealers said the banks would sell the bulk of these bonds to the interested corporates in the secondary market adding that there was enough demand for long-term bonds among large corporates and provident fund/pension fund managers.

They also said that the recent tumbling of the stocks triggered by worries about the US credit market had further increased the demand for long-term bonds. The PIBs auction held on August 21 was the first of the current fiscal year and the government plans to hold several more in expectation of raising non-bank debt.

The money raised from PIBs sold to the corporates directly or through banks forms part of the non-bank borrowing of the government. But if banks hold PIBs and do not sell them to corporates then the money thus borrowed constitutes the government’s borrowing from banks.

At the start of this fiscal year, the government had decided to borrow more from non-bank sources, which is least inflationary, to help SBP in its fight against inflation.

In July 2007 annualised CPI inflation fell to 6.4 from 7.6 per cent in July 2006, as the markets remained abuzz about tightening of the monetary policy.

Some analysts say the decline in July inflation was not entirely due to subdued inflationary expectations in anticipation of a tighter monetary policy: they say it owed as much to a high-base effect.

And whereas overall CPI inflation declined to 6.4 per cent, food inflation rather shot up to 8.5 in July 2007 from 7.4 per cent in July 2006. Similarly, annualized SPI inflation, or inflation for the poor, accelerated 9.8 up from 8.9 per cent.

The increase in food inflation and SPI inflation (which reflects the increase in prices of essential commodities including eatables) shows that the government has failed in improving food supplies.

It also betrays the government failure in checking bad business practices like hoarding, cartel making and profiteering. Rising wheat prices provide a good example of how hoarding takes its toll on the price-line.

On the external front, the trade deficit marginally narrowed down in July this year compared to July last year (See table).

However the deficit, still above a billion dollars, was still more than what it should have been. Pakistan has set imports and exports target at $30 billion and $19.2 billion respectively for this fiscal year. This means that the full year trade deficit should not be more than $10.8 billion, which boils down to $900 million per month.

Home remittances rose more than 31 per cent to $496 million in July raising hopes that the full year remittances would reach $6 billion. Foreign direct investment also showed an increasing trend but portfolio investment recorded a decline.

Senior bankers said that portfolio investment might continue to show a declining trend in August as well. Already between July 1 and August 22 the inflow of foreign exchange in special convertible rupee accounts recorded a net outflow of $194 million. Foreign investors including non-resident Pakistanis maintain these accounts mainly to invest in Pakistan’s debt and equity markets.

This huge outflow from SCRA lowered the supply of dollars in the inter-bank market and the rupee began to decline.

Between August 1-24, the rupee shed 31 paisa or 0.5 per cent of its value against the dollar. It fell to 60.68 a dollar on August 24 from 60.37 a dollar on July 31. Bankers attributed the fall of the rupee also to the fact that banks are now financing up to 30 per cent of oil imports and the central bank was selling dollars to them to finance the remaining 70 per cent.

Last month the SBP partly broke the three-year old practice of providing dollars to banks for financing oil imports.

It asked banks to arrange foreign exchange from their own resources to finance up to 30 per cent of oil imports.

At the close of the week on Friday (August 24) the rupee shed eight paisas against the dollar as, according to bank treasurers, bot corporates and the central bank made some dollar buying from the market.

On Thursday the Supreme Court had ruled that exiled former Prime Minister Nawaz Sharif and his brother Shahbaz Sharif had the freedom to return Pakistan. “This also had a psychological impact on corporate buyers of foreign exchange,” said treasurer of a local bank adding that several corporates bought dollars through their banks on Friday fearing that political volatility might weaken the local currency.

Bankers said the rupee might lose further against the dollar in the coming weeks. But they said that with foreign exchange reserves at a record $15.8 billion, the SBP had the capacity to intervene in the market to end volatility in exchange rates. Some bankers said that SBP bought dollars from the market on Friday with the same purpose.

Indicator July FY08 July FY07

Imports $2.57bn $2.46bn

Exports $1.48 $1.34bn

Home Remittances $496m $377m

FDI $188m $164.8m

Privatization Proceeds — —

Portfolio Investment (Private) $12.3m $19.5m

CPI Inflation 6.4% 7.6%

Food Inflation 8.5% 7.4%

Indicators End Period End Period

Rupee Vs Dollar (monthly average) 60.40 July07 60.27 July07

WA lending Rate 11.33% June07 10.40% June06

WA Deposit Rate 3.98% June07 2.89% June06.

—Mohiuddin Aazim