THE recently-released data on large-scale manufacturing showing 2.13 per cent growth in the July-December period, and 21 per cent gain in the Karachi Stock Exchange-100 Index in less than eight months indicate that transmission of monetary policy signals has picked up pace.

Faster transmission of monetary policy signals is benefiting the corporate sector even at a time when corporations are struggling to get their due share in electricity and gas, and law and order situation is far from ideal. Oil and gas exploration companies, electricity generating units, cement makers and the producers of food and fast-moving consumer goods have reported an uptick in their earnings during July-December last year.

A well-placed source in SBP told Dawn that from now onwards the central bank would put in place a mechanism to ensure that the recently-seen fast-paced transmission of monetary signals is sustained.

“First, we’ve decided in principle not to keep injecting cash ahead of T-bills auctions just to facilitate sufficient participation of banks. Liquidity injections would continue, however, based on a wider range of considerations,” one of the sources said. “Our OMOs (open market operations) would now be aiming more at balancing liquidity levels and this balancing would be dictated by broader considerations that assign equal weight to seasonal changes in liquidity levels and the pace of demand of private sector credit along with the government’s borrowing requirement. And now we’ll be more open in stressing upon the government to stop breaching its borrowing limits from the central bank,” he added.

Concerns of low economic growth and lower-than-required pickup in industrial activity continue to build pressure on the State Bank of Pakistan to keep interest rates low. But changing roles of market players makes it difficult for it to steer the interest rates through its monetary policy with confidence.

Over the last few years the government’s role has gradually become more important with regard to maintaining the direction of interest rates. The government has been and still is the largest recipient of bank loans. And it is the ministry of finance that decides on cut-off yields of treasury bills and bonds.

One can easily imagine what happens under this scenario when the government lifts more than the targeted amount of money from banks at times when SBP tries to move interest rates down.

Banks, after overinvesting in treasury bills run short of liquidity. But they don’t bother to see if they are making adequate loans to private sector businesses (PSBs) knowing that SBP would pump in cash in the market. On many occasions SBP injects liquidity even ahead of T-bills auction to facilitate fuller participation of banks.

“This is more than the traditional crowding out phenomenon,” says a former member of the board of directors of SBP. “It looks as if the central bank’s role in setting the direction of interest rates is being compromised.”

Despite this and a few other challenges in formulating and implementing the monetary policy, including frequent breaching of the government’s borrowing limits from SBP, proper employment of key policy tools in quite a transparent interbank market has yielded good results.

“Take for example a faster transmission of monetary policy signals,” says treasurer of a local bank citing various indicators that show that easing of monetary policy has had a desirable impact on financial markets and the corporate sector in a short span of time. On August 13 last year SBP slashed its key policy rate by 150 basis points to 10.5 per cent. It chopped the rate further to 10 per cent on October 8 and to 9.5 per cent on December 17. “This 250bps slashing in less than six months has brought about a lot of change in a matter of months — in credit supply to PSBs, in stock market, in banks’ lending rates and in terms of spreads between key rates of various kinds. The point here is, monetary easing has never had a faster impact.”

Between August 2012 (when SBP started the most recent phase of monetary easing) and February 8 (when it put its reverse repo rate on hold and its repo rate increased by 50bps) KSE-100 index has risen to 17,700 points from around 14, 600 by end of July showing a huge gain of 3,100 points; banks’ fresh average lending rate has come down to 11.65 per cent in December 2012 from 13.58 per cent in June shedding 193 basis points. Investment in National Saving Schemes between July-December last year soared to Rs255 billion outweighing the full fiscal year 2011-12 investment of Rs188 billion; banks’ investment in non-bank financial institutions (NBFIs) shrank to Rs118 billion in December from Rs198 billion in June depicting a sharp decline of Rs80 billion and their net credit supply to PSBs during July-December last year shot up to Rs153 billion from only Rs18 billion in full FY12.

The key question is how all this happened at a time when transmission of monetary policy signals was subjected to interruption by (a) excessive influence of government borrowing from commercial banks with the government enjoying the liberty to decide cut-off yields on debt papers; and (b) banks’ long-stretched reluctance to make new loans to private sector businesses.

Observers of money market say that a big cut of 150bps followed by two consecutive trimming of 50bps each in the SBP policy rate successfully changed inflationary expectations — and all manifestations of successful transmission of the monetary policy signals followed naturally. Those who forward or buy this theory say that changing inflationary expectations is a key objective of monetary policy adding that in a least-documented economy like ours and in a situation when an economy is in the process of developing a reliable yield curve, inflationary expectations play a more important role than the actual inflation numbers do.