WHAT do you call it when your words are contradicted by your deeds? I’m pretty sure whatever the word, it’s a very unkind one.
I don’t want to be unkind to our central bank. It’s one of the last government institutions that still commands some respect, some credibility, some gravitas. Its staff has performed admirably in some very difficult situations when the foreign exchange markets froze or panicked.
But the last monetary policy announcement leaves me scratching my head in bewilderment. If everything the bank is saying in the announcement is true, then surely the case is very clear against cutting interest rates.
Consider this. The policy discount rate, the key interest rate that is used as a benchmark for all varieties of other interest rates in the economy, is first and foremost a signalling device, kind of like the lighthouses of older times that lit up dangerous waters for ships that were skirting too close to the coastline.
In this case, the policy discount rate is supposed to be the key signal to the government — the largest consumer of bank resources — that it is borrowing too much.
In our time of deep dysfunction, the conventional view of interest rates as a protective measure against inflation is too quaint. High interest rates are needed precisely to make borrowing prohibitively expensive, and thereby induce the government to look elsewhere for its fiscal requirements.
Interest rates as a signalling device worked very well in the second half of the last fiscal year.
The report notes, for instance, that 13 treasury bill auctions were held in this period, in which “the fiscal authority was unable to meet its target in seven auctions. In five of these auctions the fiscal authority had offers of more than the targeted amounts. This shows that the fiscal authority had the opportunity but it preferred not to meet the target to avoid paying a higher price”.
Get it? The growing cost of debt deterred the government from borrowing from the market, meaning the signal worked. But the lesson for the government was washed away because “[i]nstead, it accessed the SBP to meet its borrowing needs and breached the requirements of the SBP Act to ensure quarterly zero borrowing from the SBP”.
When the markets demanded the premium, the government balked and instead printed the money it needed to meet its requirements. Of course this taught the banks a valuable lesson: you can’t push the government too far.
It was almost the same time last year when yields in 12-month treasury bills were lapping up against 14 per cent, the highest they’ve been in many years, and the government struck back with a two percentage point cut in the discount rate in October, bringing those yields quickly down below 12 per cent.
But even here the government remained uncomfortably addicted to bank money. It returned again and again to borrow more but behaved like a petulant teenager, demanding money, chaffing at the obstinately high yields, famously scrapping all bids in all tenors in one tantrum of an auction in December.
That, of course, came shortly after the government had lifted another mammoth Rs391bn from the banks in order to settle the circular debt, right before they launched that so-called ‘recovery drive’ in the power sector. Remember that? The recovery drive petered out a long time ago, but the debt will be with us for a long time to come.
In the second half of the fiscal year, from January to June, the government was becoming increasingly weary of the high yields being demanded by the banks.
Resort to borrowing from the State Bank increased, by almost 42 per cent year on year, rising to Rs312bn by the last quarter of the fiscal year. “This shows complete fiscal dominance of the balance sheet of the SBP and renders any effort by the SBP to bring monetary stability completely futile” notes the monetary policy announcement. Spare a tear when you get a chance.
Throughout the announcement, the poor central bank bleats out its protests at the “fiscal authority’s” profligate ways. Words of this sort are found all over the report: “These fiscal borrowings from the SBP are despite the commitments announced in the budget for FY12, reassurances made during the year, and more importantly, explicit requirements of the SBP Act”.
It’s fair to expect that election-related blowouts in government expenditure have yet to happen, which means the real looting has yet to begin.
If already, at this early stage in the election cycle, the government’s spending and mismanagement of its cash flows are enough to reduce the central bank to tears, then one wonders why they’ve decided to reduce interest rates at this time because a high cost of borrowing is the most powerful deterrent to borrowing.
I seriously doubt that this step has anything to do with trying to kick-start investment as stated in the announcement. That’s just public relations spin. No, the slash in the discount rate has everything to do with bringing down the cost of borrowing for the government, perhaps in the loopy hope that cheaper availability of bank credit will mean less recourse to State Bank borrowing.
There are difficult days coming. A showdown of epic proportions looks to be building up as a chaotic election approaches. It’s going to become harder and harder to tell, in the days to come, who is in charge, who is calling the shots.
In times such as these, the few government institutions that are able to stand aloof from the political maelstrom have a very important role to play to ensure that crucial areas of the economy, such as management of the money supply, are safeguarded from the political storms that will be blowing with increasing ferocity.
The SBP is the biggest such institution, and it must do more than bleat out its protests at the profligacy of the “fiscal authority”. It must ensure that its words are matched by its deeds.