KARACHI, Aug 31: Karachi interbank offered rate (Kibor) has become a bit stable in the first two months of the current fiscal year, after showing a sharp spike in the last year. This means that the corporates and businesses that make Kibor-based borrowings would not see as much increase in their financial cost as in the last fiscal year.

In fiscal year 2005 ending in June last the benchmark six-month Kibor shot up from 2.90 per cent to 8.71 per cent showing a big rise of 581 basis points. But in the first two months of this fiscal year i.e. in July-August 2005 six-month Kibor rose by only 16bps to 8.87 per cent. Chances are that Kibor would continue to rise at the same pace throughout the rest of this fiscal year — unless the economy comes under extreme inflationary pressures.

What explains a huge increase of 581bps in six-month Kibor in the last fiscal year is that the central bank kept increasing interest rates throughout the year to fight rising inflation. Since the SBP had to fight inflation a bit more aggressively in the last quarter of FY05, six-month Kibor also showed the biggest increase during that quarter.

When Kibor moves up, it increases the cost of bank borrowing for the private sector as most banks now lend on floating interest rates and six-month Kibor has become the benchmark for short-term lending. Banks charge premiums over Kibor while making loans and the amount of premiums depend on the repaying capacity of the borrowers plus their relationship with the banks. Blue chip companies with proven records of repaying bank loans on time get loans as cheap as Kibor plus one per cent. Most corporates and businesses have to pay 2-4 per cent over Kibor. Small and medium size enterprises and least-known and weak corporates and businesses pay even higher premiums.

Commercial and central banker say Kibor would not rise sharply during the current fiscal year chiefly because the SBP is less likely to tighten interest rates as aggressively as it did during the last fiscal year. In FY05 the central bank had to increase its benchmark weighted average yield on six-month treasury bills by 573bps to 7.94 per cent to keep inflation in check. Despite this inflation moved at an average rate of 9.28 per cent during the last fiscal year due to a higher than estimated economic growth of 8.4 per cent and also because of the government’s failure to check manipulative increases in food prices and the SBP’s initial hesitance in accelerating interest rates.

The government has set eight per cent inflation target for this current fiscal year assuming that the economy would grow by seven per cent. In the first month i.e. in July 2005, inflation rose by 8.99 per cent year-on-year which indicates that the government would find it difficult to keep inflation at the targeted level during the entire fiscal year. Increasing international oil prices and the possibility for shortages of food items coupled with soaring real estate prices indicate that inflation would keep rising at a fast pace during the current fiscal year.