Results from successful bids in the latest T-bill auction held on Dec 5, 2018. The government borrowed two trillion rupees at an average yield of around 10.3 percent, mostly in 3 and 6 month tenors, while nobody bid for bonds that have a 12 month maturity. Notice that in the 6 month paper, the weighted average of the yields bid by the banks is identical to the cut-off yield (meaning good bets were placed) while in 3 month paper the weighted average yield is slightly below the cut-off yield (the banks lost a little bit). Since the amount of money being borrowed is so large, even fractional differences in the yields can be significant.
The cycle of interest rate hikes began in January 2018 when the State Bank raised the policy rate by a meagre 25 basis points (bps), or 0.25 percent “in order to preempt overheating of the economy and inflation breaching its target rate.” The next hike came in May, this time slightly larger increase of 50bps followed by another hike of 100bps in July and another 100bps in September. After the latest hike of 150bps in November, the policy discount rate of the State Bank went from 5.75 percent at the start of the year to 10 percent by November. Now the markets are in fear of what will happen in the next monetary policy announcements due in January and May of 2019 respectively.
In response to this cycle of interest rate hikes, banks abandoned longer tenors and rushed into 3-month bonds instead. In the last 26 auctions, starting from the one on Dec 20, 2017, no successful bids were placed in 6- and 12-month bonds in all seven auctions. In fact, no bids were placed in 12-month bonds at all throughout this period, indicating that markets could not see what will happen over one year, and were very reluctant on the outlook even for 6 months. Almost all the money the government picked up in these auctions was in 3-month bonds. Nobody was willing to go any longer with the government with any substantial amount.
There were good reasons for this reticence. This was, after all, the year it all blew up — the three years of real sector growth that former finance minister Ishaq Dar used to boast about. This was the year Pakistan ran a record $18 billion current account deficit, when its reserves ran down to barely being able to cover more than one month’s imports, when it was forced to approach the International Monetary Fund (IMF) and, very importantly, when it was left largely rudderless due to the political storms raging in the run-up to the elections, and the appearance of a new government after the election that said it needed 100 days to find its feet.
The auction on December 5 was the first to be held after those 100 days were over, and although there was healthy participation owing mainly to another massive 150bps increase in interest rates by the State Bank only days earlier, all the bids were again concentrated in 3-month bonds.
The clouds of uncertainty have clearly not parted. If the mood of the markets has not changed despite assurances from the government that they have found the resources to plug the external financing gap for this year, and despite growing hikes in interest rates, then the next auction scheduled for Dec 19, 2018, should show diminished participation. At the moment the government is expecting to lift 90 billion rupees in fresh borrowing from that auction. If the markets feel that the economy has more adjustment to undertake, that interest rates could rise substantially one more time in the January or May monetary policy decision, then the amounts bid will be smaller than they were on Dec 5 and will continue to be concentrated in 3 month tenors.
Since markets are cold and calculating, and totally impervious to hype, their sentiments are a good barometer of how successfully any government has managed to command business confidence in the economy. The government can sell its story of having pulled the economy out of its downswing by securing external financing, but whether or not the markets buy this story will be the real test.
The writer is Dawn’s Business Editor
Published in Dawn, EOS, December 16th, 2018