As the year 2001 slips into the corridors of history—it is leaving behind a tale of triumphs and failures in every sphere of life. Banking is no exception.
Interest rate regime: For banks the dawn of the year 2001 was too misty: most of them had not recovered yet from the shock caused by an trailblazing liquidity crunch that had hit them in December 2000. Some banks had to borrow overnight funds from the SBP at a high rate of 45 per cent on December 31 to fill in the gap between their liabilities and assets. That was too much for them. The discount rate then was only 13 per cent. This crude reality rankled with the banks throughout the year. They grew skeptical of the State Bank moves for they felt that it was the failure of the monetary policy that plunged them into a crippling liquidity crunch.
But the central bank had its own story to tell. The SBP officials somehow conciliated the banks—and made them believe that it was not the failure of the monetary policy but unreasonable IMF conditions that forced the SBP to keep the market dry at the end of 2000. Banks were not sold to this idea. But they accepted the things as they were—and added this to their work ethics: Be on your guard—be skeptical while inter-acting with the regulators.
The monetary policy remained more or less subservient to the dictates of the $600 million IMF standby agreement that expired in September 2001. The central bank had to follow a tight policy in the first half of 2001 to keep its net domestic assets at the levels prescribed in the SBA. That remained a constant problem for the banks—and they failed in meeting the private sector credit demand. But the tight monetary policy naturally kept the exchange rate stable to some extent.
When the State Bank started relaxing the policy in the second half of the year—the rupee began to show signs of weakness in the inter-bank and free market. It was not before October 2001 that the SBA expired and the SBP had some room to make its own moves.
The SBP further relaxed the monetary policy by slashing its discount rate by three per cent to signal banks to make cheaper credit available to the private sector. But banks would not do it for a host of reasons—the most immediate being another liquidity crunch that rocked the banking system in the last quarter of the year 2001. This was a major failure of the banking system in the outgoing year: The SBP discount rate fell from 13 per cent at the beginning of the year to 10 per cent in October but weighted average lending rates of banks remained almost pegged around 14 per cent. (To add insult to injury weighted average deposit rate that stood closer to 6 per cent at the start of the year fell to 5 per cent towards the year-end.)
Export financing cheaper; The cut in discount rate and subsequent slashing of the maximum yield of six-month treasury bills made export finance cheaper in the second half of the year 2001. From April 2001 the SBP had linked—on the insistence of the IMF—the export finance rate to the weighted average of six-month T-bills rate. Under the formula adopted by the SBP for this purpose the export finance rate was fixed at 1.5 per cent higher than the weighted average cut-off of six-month T bills. Since the T-bills rate started falling in the third quarter of the calender year 2001 the exporters got the benefit in the last quarter: the export finance rate for October-November fell to 12 per cent from 13 per cent in July-September. As the T-bills rate fell more rapidly in October-November 2001, the SBP lowered the export finance rate to 10 per cent for December 2001. On December 27, the SBP cut the rate further to 9.5 per cent effective from January 1, 2002, due to falling yield of T bills in December 2001.
Prime lending rate: Meanwhile, the inability of the banks to cut their lending rates in response to the cut in SBP discount rate has embarrassed central bankers who are persuading banks to set—and make public their prime lending rates. The idea is to use the rates for mirroring any change in the monetary policy. Whereas foreign banks are in favour of introducing prime lending rates state-run banks are not. The reason is obvious. Smaller portfolios of bad loans and lower cost of operations would help foreign banks quote cheaper prime lending rates. That would put state-run banks in trouble.
Top bankers say local and foreign banks would soon reach a consensus on prime lending rates. But in another area they have already reached a consensus. That is KIBOR or Karachi inter-bank offered rates. More than a dozen local and foreign banks launched KIBOR in September. At the moment KIBOR is far from becoming a benchmark lending rate for the borrowers but it is serving well as a standard rate for inter-bank lending with some limitations.
Senior bankers say once some technical hitches are over KIBOR will become a real benchmark for inter-bank lending of all types: eventually it may also become a standard lending rate for the banks clients. The launch of KIBOR has put Pakistan on the list of those countries whose banking system is fast becoming market-oriented. It has also enabled the SBP to assess liquidity level in the inter-bank market and cut-off the yield on treasury bills accordingly while making injections into, or mopping up surplus funds from the market.
Foreign exchange regime: Whereas in the interest rate regime the year 2001 saw the historical launch of KIBOR; in the foreign exchange regime it witnessed a phenomenal rise in the reserves. Liquid foreign exchange reserves rose from $2.6 billion ($1.4 billion held by the SBP and $1.2 billion by the banks) in January 2001 to $4.6 billion by the end of the year. The reserves shot up mainly in the last quarter of the year—in the wake of September 11 2001 attack on the US soil.
At end-September 2001 the reserves stood around $3.2 billion ($1.7 billion held with the SBP and $1.5 billion with the banks). The amount recorded a huge increase of $1.4 billion within next three months. The reserves shot up as the US offered $600 million aid in grant to Islamabad in recognition of its support to the US war on Afghanistan—and the IMF released $109.5 million first tranche of $1.3 billion poverty reduction and growth facility. In addition to this the banking system also received more foreign exchange from overseas Pakistanis than in the past. Even resident Pakistanis who had placed huge sum of money abroad brought back part of the same when anti-money laundering laws were tightened globally after September 11.
The huge inflow of foreign exchange kept Pakistan current in external debt payments throughout the year besides stabilizing the rupee towards the year-end.
On the first working day of the year 2001 the rupee had opened around 58 to a US dollar in the inter-bank market: by the close of the year it was trading around 60.30 per dollar. So the local currency depreciated by only four per cent against the dollar in the last calender year. This would not have been possible had the banking system not been flooded with foreign exchange inflows in the last quarter of 2001 that reversed much of the losses the rupee had suffered previously.
Fast-paced liberalization: The State Bank moved rather faster than ever before towards liberalization of foreign exchange regime in the outgoing year. On March 31 it allowed banks and non -bank financial institutions to use their fresh foreign currency deposits freely for lending or investment in or outside Pakistan. Before that investment abroad of these deposits was banned. In May the central bank also raised the maximum amount of foreign exchange quota for business travels from $6000 to $9000: In November the SBP lifted all quotas allowing private and business travellers to buy as much of foreign exchange from the banks as they need. Back in May the State Bank had also allowed tax paying Pakistani companies to make equity investment abroad. The central bank had also allowed them to buy foreign exchange from the inter -bank market for this purpose.
In August the SBP removed Nostro limits of the banks. That is it withdrew the restriction from the banks on their holding of foreign currencies abroad. And in November the SBP allowed banks to restart buying and selling of foreign exchange among themselves—even if the transactions are not meant for customers.
Part of this fast-paced liberalization of foreign exchange regime was carried out under the terms of the IMF standby loan.
Unification of exchange rate: In July 2001 the SBP decided— also to meet an IMF condition—to replace money changers with foreign exchange companies. A committee was formed to lay down the rules that would govern the working of these companies. The committee headed by one of the executive directors of the SBP has almost finished its task and the bylaws for the proposed companies may soon be approved.
With the creation of foreign exchange companies the 400 and odd money changers would cease to operate: these companies that would be set up with much larger paid-up capitals and monitored more strictly by the SBP would be allowed not only to transact business in cash but also to handle telegraphic and electronic transfers of money. The idea is to regularize the inflow of foreign exchange coming from abroad through semi-regulated and least-monitored money changers.
This is being done for the unification of inter-bank and open market exchange rates that may eventually lead to capital account convertibility of the rupee.