THE hefty increase of up to 129bps in the rates at which commercial banks lend money to the government through their purchases of T-bills underlines two major trends. First, it clearly signals that the market is anticipating yet another hike in the State Bank’s policy rate later next month. Second, the cash-strapped government is left with fewer options to finance its swelling fiscal deficit as multilateral and bilateral foreign flows dry up. The banks’ decision to hike their yields beyond what was being anticipated is informed by projections that price inflation will stay elevated in the near term, and the current account deficit may widen on the back of the global commodity super cycle and the likely repeal of the fiscally unsustainable energy subsidies as demanded by the IMF. With the spread between the T-bill yields and the SBP policy rate of 12.25pc extending up to 274bps, chances are that the bank will be forced to raise its key rates. Currently, matters are beginning to resemble the situation in December, when public debt targets were increasing, inflation was soaring and the market was demanding higher rates from its largest borrower — the government.

But the expectations of inflation are not the only driver of the latest hike in the price of government debt. That the government settled to pay a higher premium charged by the banks and collected more debt than it had actually targeted, betraying its desperation to finance its growing deficit, also encouraged the banks to raise their price. The new finance minister says that the fiscal deficit could surge to Rs6.4tr — or equal to 10pc of GDP — against the budgeted estimates of Rs3.9tr due to ‘unbudgeted’ energy subsidies and other expenditure. We don’t have many options to force down T-bill yields or avoid raising interest rates, which will push the government’s debt-servicing costs, affect private investment decisions, spike the expense of doing business and ultimately, further slow down growth. While the SBP can reverse this trend by injecting liquidity into the market through its purchasing of debt from the secondary market and increasing the duration of its injections to 63 days to fix the costs of banks, the government must quickly arrange adequate foreign funding to reduce its domestic borrowings in order to finance its budget. Additionally, the government needs to come clean on its plans to roll back energy subsidies in order to dilute inflation expectations.

Published in Dawn, April 29th, 2022