BANKS exhibited their craving for investment in zero-risk government treasury bills in the very first auction in the new fiscal year. And the government that heavily relied on printing new currency notes in last fiscal year borrowed more-than-targeted amount of money from the banks through T-bills.

The federal government borrowed Rs286 billion exceeding the pre-announced target of Rs225 billion by 27 per cent. Despite a 94 per cent increase in their private sector lending in FY12 (which rose to Rs235 billion as on June 29) risk-shy banks generated bulk of interest income through investment in government papers.

But why the government borrowed over and above the target? A top official of the ministry of finance says : “In FY12 we had relied too much on central bank borrowing and our borrowings from commercial banks had only slightly higher than what it was in FY11.

Excessive borrowing from the SBP was not only over and above the limits prescribed under fiscal responsibility law but was also highly inflationary in its nature. ”

Federal government borrowed Rs564 billion from the SBP in FY12 whereas it had made a net retirement of Rs8 billion SBP loans a year earlier. In contrast the government borrowing from commercial banks totalled Rs693 billion in FY12—up just 12 per cent over the FY11 borrowing of Rs617 billion.

In the TBs auction on July 11 banks were so eager to invest in TBs that most of them submitted much larger bids for TBs than their actual capability of investment. That was exposed the very next day when the central bank injected Rs212.5 billion into the banking system for seven days through reverse repo facility.

“If you look at the size of total bids received in the TBs auction on July 11 (Rs416 billion) you’d think banks were wallowing in cash.

But after the SBP accepted Rs308 billion worth of bids (with actual realised amount being Rs286 billion) banks became poorer and the central bank had to provide liquidity support the very next day,” remarked treasurer of a large local bank. “This shows that banks had come up with bids not supported by their actual surplus funds.”

And banks had priced even their phony bids so cleverly that the weighted average yield on accepted bids of all the three tenures, three-month, six-month and one-year did not decline. In all the three tenuresthe yield worked out to be only two to three percentage points lower than what they were at the time of the last auction in June.

“Such practices of banks hinder development of realistic yield curve,” was the candid observation of foreign exchange dealer.

Meanwhile, during the week ending on July 13 the rupee closed at 94.37 a dollar, down from 94.04 a week earlier, losing 33 paisa or more than 0.3 per cent value within a week. After 10 per cent depreciation against the greenback in the last fiscal year ending in June, the rupee had shown a reasonable recovery of 51 paisa in the first week of this month on news of reimbursement by the US of $1.2 billion.

“Basically, the rupee is under pressure because fuel oil import bills held up for sometime, that are now being paid after the federal government cleared some of the financial obligations of oil marketing companies. Since this process is likely to continue for some time we can’t see any big recovery (in the rupee value) unless we get some sizable inflows (of foreign exchange),” said a bank official.

But treasurer of another bank said that traditionally high inflows of home remittances during Ramazan may ease some pressure on the local currency. Ramazan is due to start from the third week of this month.

“We were anticipating immediate release of at least part of our stuck-up coalition support fund (of around $1.2bn) after the July 3 decision of resuming NATO supply lines. But that has not happened so far and the current account and balance of payments deficits are still there,” said a foreign exchange dealer at a foreign bank.

There is another factor keeping the dollar strong against the local currency. Normally, imports bills rise ahead of Ramazan as the country imports more of edible oil and pulses to meet additional demand. This often offsets the impact of increased inflows of home remittances.

“And when it happens at a time when external sector fundamentals are weak the rupee is hit,” according to another foreign exchange dealer at a local bank.

“Besides, in view of weak external sector situation and its consequent impact on forex reserves, the central bank cannot provide enough support to the market (through temporary dollar selling to banks).”—Mohiuddin Aazim