THE State Bank has taken the unusual step of issuing a forward guidance in its latest monetary policy statement to tell markets that no raise in interest rates is likely in the near term, but it remains to be seen whether this will mollify sceptical buyers of government debt. The most likely explanation for why the regulator felt it necessary to take this step is the lacklustre participation that recent debt auctions have seen. Most bids are now congregating around shorter three-month tenors in Treasury bills, which is usually an indication that banks are expecting a rate hike. In the last auction conducted on Jan 13, 96pc of the realised value was in three-month paper. With its forward guidance, the State Bank seems to be telling the banks that their anticipation of a rate hike is futile and they should modify their bidding behaviour.

The next debt auction is scheduled for Jan 27 and it will provide an interesting opportunity to test the impact of the forward guidance. If the banks refuse to heed the State Bank’s words and continue crowding around the shortest tenor on offer, it will be a sign of the futility of the exercise. At that point, the central bank will have some decisions to make. Most market analysts were not expecting a rate hike at this point in any case, but the unusual meeting between the State Bank governor and the prime minister only days before the monetary policy decision has given rise to the impression that the central bank might have been prodded to not raise rates at this time. A rate hike would have adverse consequences for the nascent recovery underway in the economy, and that is something the government is understandably reluctant to see happen. But if markets are not assuaged, and pressure from the IMF is strong, the central bank might have limited options because continuing with low rates could have implications for the exchange rate, as well as the profile of the stock of government debt.

Published in Dawn, January 25th, 2021

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