KARACHI, March 31: The State Bank on Wednesday allowed further hike in benchmark six-month treasury bills rate. This has sent a clear signal across the financial system that the SBP has really started making adjustments in its lax monetary policy.

The central bank had to sell a higher than targeted amount of TBs to let the cut-off yield inch up. It sold Rs20.68 billion six -month TBs against the target of Rs15 billion at a cut-off yield of 1.84 per cent up six basis points from the previous level of 1.78 per cent.

"This reinforces our earlier signals that we are concerned about rising inflation and are taking measures to keep it in check," said a senior central banker who refused to go on record.

In January SBP had allowed the cut-off yield on six-month TBs to rise modestly from 1.65 per cent to 1.71 per cent in an effort to stem rising inflation by containing growth in monetary assets.

Then in February it again allowed the cut-off on six-month TBs to inch up to 1.72 per cent. In a third move made earlier this month the central bank raised the cut-off yield on six-month bills to 1.78 per cent.

The fourth hike in the yield that came on Wednesday confirms beyond doubt that the process of adjustment in monetary policy has started - and that interest rates have already bottomed out.

"Actions speak louder than words," remarked a senior central banker when asked whether the latest increase in TBs yield was a follow-up of what the SBP said on monetary policy in its second quarterly report.

The report released on Tuesday explained the rationale for maintaining a loose monetary policy stance in the first half of this fiscal year. But it said "if inflation does accelerate" the SBP stands ready to move aggressively and adjust the monetary policy accordingly.

CPI inflation or inflation measured by consumer price index recorded a year-on-year increase of 3.49 per cent in the first eight months of this fiscal year. The SBP report now projects it to settle around 3.8-4.2 per cent against an initial target of 3.9 per cent.

Central bankers say CPI inflation looks set to rise beyond the original target primarily because the economy is showing signs of faster than projected growth. The SBP said in its second quarterly report that the real GDP would rise by 5.5-5.8 per cent against the initial target of 5.3 percent during this fiscal year.

But central bankers say privately that this projection which was made on the basis of the data available for the first half of this fiscal year may have to be revised further upwards in the light of fresh data. That explains why SBP has already started tightening the monetary policy without saying so "in the name of making adjustments in the policy."

Senior bankers said the central bank sold Rs20.68 billion six- month TBs on Wednesday against the demand of Rs28.3 billion but higher than the target amount of Rs15 billion. They said the SBP had to sell higher than targeted volumes of TBs to let the cut-off rise modestly.

"Otherwise they (SBP) could not have reinforce their earlier signals that interest rates have bottomed out and that they are going to make adjustment in the monetary policy," said treasurer of a foreign bank.

One pointer to the fact that the interest rates have really bottomed out is that the weighted average lending rate of all the banks combined has moved up from 5.04 per cent at end-January to 5.30 per cent at end-February 2004.

SBP has kept its loose monetary policy stance unchanged since the middle of November 2002 when it had last reduced its discount rate by one and a half percentage points to 7.5 per cent.

Though the discount rate still remains unchanged the gradual hiking of T-bills rate shows that effectively tightening of monetary policy has started.

What has prompted SBP to allow a gradual rise in TBs rate is that the monetary assets or M2 have increased much faster than targeted so far during this fiscal year.

In eight and a half months to March 13, 2004 M2 grew by 12.10 per cent surpassing the full fiscal year target of 11.06 per cent. And since currency in circulation accounts for about 41 per cent of the increase in M2 it seems more logical for SBP to contain money supply by allowing the interest rates to bottom out. Hence the increase in TBs rates.

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