THE SBP decision of exempting deposits of one year and above from cash reserves requirement and increasing CRR from five to seven per cent on less-than-a year deposits had a neutral impact on liquidity levels.

(A two percentage-point increase in CRR on less than a-year deposits means banks will have to dish out an additional Rs44.8 billion or so, for such deposits are estimated at Rs2260 billion. On the other hand, withdrawal of five per cent CRR from deposits of one year and longer maturity means freeing up of Rs48 billion, as the estimated value of these deposits is Rs960 billion).

Bankers say, however, that liquidity levels in the banking system are high for several other reasons: foreign exchange inflows continue to rise, demand for private sector credit is low and banks are shy of investing too much in government securities anticipating further rise in treasury bills yields.

The State Bank did increase the yield on the benchmark six-month T-bills by 20 basis points in an auction conducted immediately after the announcement of the monetary policy on July 31. But despite that the central bank could not raise the targeted amount of funds through the bills. Latest data on private sector credit has not been released bankers involved in credit disbursement say that the demand for credit is low because of higher interest rates. That the foreign inflows have been on the rise is evident from the fact that foreign exchange reserves rose from $15.60 billion at end-June to $15.79 billion on July 28.

Since the SPB has adopted a tighter monetary policy it cannot leave the banking system excessively liquid.

That is why it is draining out excess liquidity through OMOs or open market operations to ensure meeting the ultimate objective of a tighter monetary policy i.e. to keep inflationary pressures in check.

On August 2 the State Bank conducted an OMO and sucked in Rs15.7 billion for five days and on August 3 it mopped up Rs38 billion for four days through another OMO.

Bankers said that on both days the SBP drained out much lesser than the actual amount of liquidity available in the market, which helped in keeping KIBOR from rising too fast.

When the central bank had announced its monetary policy, the benchmark six-month KIBOR was at 9.96 per cent. Three days after it rose to 10.18 per cent, showing an increase of only 22 basis points in response to the tightening of the monetary policy. Had banks not been excessively liquid when the new monetary policy was announced and had the SBP not been careful to suck in only part of excess liquidity, KIBOR would have surged much faster.

But bankers involved in credit disbursement say that after the increase in SBP discount rate from 9.5 to 10 per cent, banks are going to increase their lending rates by up to one percentage point.

Top bankers officially say that banks would not raise lending rates for most of their clients and that the rate increase even for a small percentage of their clients would be nominal. “But frankly speaking, I am going to increase our lending rates across the board by at least 50 basis points,” confided head of credit division of a large local bank. “For some customers, particularly the smaller ones and those seeking consumer credit, the rate rise may be more than 100 basis points,” he said citing past practice.

Whereas the stage is set for further interest rates hike—and that is one way of containing inflation.

But as food inflation is showing no sign of receding, monetary tightening alone cannot be helpful in keeping inflation at the targeted level of 6.5 per cent this year.

In the last fiscal year when overall inflation rose 7.8 per cent food inflation was at 10.3 per cent. And the post-budget increase in the prices of essential items including wheat and wheat flour, rice, pulses and cooking oil etc. suggests that food inflation will remain high in this year too. (On August 3, wheat traders raised the price of wheat by Rs35 per 100 kg and flour millers increased the price of wheat flour by Rs30 per 80 kg).

Advisor to Prime Minister on Finance Dr. Salman Shah said last week that the government was planning to increase domestic prices of oil following a jump in their international prices. When this happens, and he indicated that it might happen soon, it would set in motion another cycle of inflationary pressures.

It is time the government launched a crackdown against hoarders of essential commodities and took other steps to improve food items supply to keep food inflation in control.