THE T-bill auction results on Wednesday underscore that the State Bank’s credibility is at its lowest point at the moment. The money/bond market snubbed it as banks kept the cost of fresh government borrowings of Rs1.3tr unchanged at the higher level of the previous sale of the short-term debt instruments on Dec 1.

Higher premiums being charged by the banks imply that they are still anticipating a further increase in the interest rate in the immediate to near term. This is in complete disregard of the State Bank’s new ‘forward guidance’ given in its latest monetary policy statement to end uncertainty in the market and suggesting that the latest round of monetary tightening is over for the moment after Tuesday’s hike of 100bps in the key policy rate to 9.75pc.

The latest monetary policy states that the central bank feels that the “end goal of mildly positive real interest rates on a forward-looking basis was now close to being achieved”. It expects “monetary policy settings to remain broadly unchanged in the near term”. That is not all, though.

The monetary policy statement also expresses the central bank’s disapproval of the previous sharp rise in secondary market yields, benchmark rates and cut-off rates in T-bill auctions across all tenors, noting that this increase appeared to be unwarranted. The way that the banks have reacted to the latest rate increase suggests that the market uncertainty will take a while to dissipate.

It is correct that the monetary policy works with a lag. But anticipation of further monetary tightening in the wake of the expected resumption of IMF funding in the next month or two proves that the markets are not responding to the central bank’s policy assurances. They have valid reasons for their doubts, the primary one being that the bank has been too slow to correctly assess the negative impact of the unprecedented monetary and fiscal stimulus given to pump growth ahead of the 2023 election.

It had us believe that all was well with the economy and it reacted slowly to the surging inflation and widening current account deficit. And when realisation struck, the bank pressed the panic button, ditching its previous forward guidance of “gradual and measured” stimulus tapering to mitigate the risks to inflation at the expense of its credibility.

What is also clear is that the markets are still unsure about the government’s deal with the IMF and what it means for interest rates going forward. The upward revision by the State Bank of inflation projections to 9pc-11pc and the current account deficit to 4pc of GDP for the current fiscal is being seen as rather optimistic given the upside risks. Will the central bank succeed in ending market uncertainty in the days ahead? We will know at the time of the next T-bill auction later this month.

Published in Dawn, December 17th, 2021