LOOKING at the current scenario, there are few chances that banks and other money market players will again face the see-saw movements of interest rate in 2002.
With no stricter monetary targets in the PRGF agreement coupled with the fact that pressure on Pak Rupee is now almost over, the SBP’s easy monetary policy may continue in calendar year 2002 unless the tension between India and Pakistan continues for a longer period.
The recent downward adjustment in the profit rates of DSC (Defence Saving Certificates), T-Bill rates and PIB rates in the secondary market hints at lower rates in the year 2002. A reduction of 50 to 100 basis points in discount rate in January 2002 cannot be ruled out also. Currently the discount facility is at 10 per cent.
Interest rates on 10-year DSC has been reduced from 15 per cent to 14.1 per cent effective from January 1, 2002 for a period of 6 months. This means Rs100 investment today will generate Rs375 (inclusive of Rs100) at the end of 10th year. Earlier the payment received in the last year was Rs405. After the launch of PIB in Dec. 2000, it has been reported by the SBP that in line with understanding with the IFIs, the resulting yield curve was to be used as a benchmark to determine the profit structure on the NSS instruments especially DSC. This linking of rates of DSC with PIB came into effect from January 2001 when YTM on 10-year DSC was 14 per cent. Thereafter, the government increased the rate on DSC to 15 per cent in the federal budget effective from July 2001 in line with rising interest rates.
Last auction of T-Bill in the outgoing calendar year posted low rates in all tenure. The benchmark six-month T-Bill cut-off rate was reduced to 7.99 per cent which is 3 per cent lower than the rate that was prevailing on this instrument a year ago. The first auction of the new-year witness further slide in T-Bill returns. Similarly in case of 10-year PIB, secondary market transactions in the interbank market is posting low rates. According to dealers few transactions were executed at 11.5 per cent on a 12 per cent coupon bond.
On the fundamental side, lower interest cost may provide the much needed boost to the industrial sector that is feeling the pinch of September 11 events besides the negative repercussion of the global slowdown.
Positive interest spread might force the SBP to keep interest rates at lower levels. Official consumer price index (CPI) in fiscal year 2000-01 remained at 4.4 per cent and this trend is expected to continue in the current fiscal year, thanks to weak oil and commodity prices. Though fiscal 2001-02 inflation target is 5 per cent, the first four months has posted an inflation of only 3 per cent. Taking into account last ten years, Pakistan only had a positive real interest rate since 1998. Before that negative real returns were experienced in the range of 5-2 per cent. This is based on the difference of CPI and weighted average deposit rate (PLS and interest bearing of all schedule banks). Currently, assuming a 4 per cent inflation, the average return on deposits is somewhere between 5-6 per cent. This implies a positive spread of 1-2 per cent.
Roller coasters ride in 2001: Players in the interbank money market remained busy in predicting interest rates as the State Bank of Pakistan (SBP) kept on changing the benchmark rates throughout the year. During the calendar year 2001,the SBP changed the benchmark discount rate a record four times to achieve various objectives. These frequent changes keep bankers guessing about the actual direction of the interest rate and accordingly their investment strategy.
For analytical purposes it is better to divide the outgoing year 2001 into two halves. During the first six-months (Jan-June), the interbank market witnessed higher rates as the SBP bowed to the IMF’s stabilization programme. The government’s effort to defend the Pak Rupee and to achieve the desired forex reserves coupled with government’s decreasing reliance on the SBP resulted in higher rates in the money market.
Contrary to this, during the second half of 2001, the SBP finally started to relax its tight monetary stance as NDA and NFA targets set by the IMF under the 10-month SBA were achieved without any major problem. This helped the central bank to follow a growth-oriented policy thereby resulting in a reduction of 4 per cent in the discount rate in the second half of 2001.
T-Bills auctions: As compared to 2000, last year saw mounting activity in the fortnightly Treasury Bills auctions. Government started following the IMF’s monetary guidelines on bank borrowing at the end of 2000 whereby government started relying more on commercial bank borrowing rather than the SBP because the central bank could not afford to bear the additional burden created by a huge Rs135bn borrowing during FY00. That is why throughout the calendar year 2001, government accepted decent amounts from the commercial banks through its regular auctions.
Another interesting observation was that during 2001 the absolute difference between the SBP’s discount rate and 6-month T-Bill cut-off rate was 1.5 per cent on an average as compared to 3 per cent during 2000. This decrease in spread is mainly on account of government’s greater reliance on schedule banks borrowing through T-Bills in 2001 as against 2000 for the reasons already discussed. New mechanism: With declining speculation in the foreign exchange market and after achieving the monetary and forex reserves target as dictated by the IMF under the 10-month funding package, the SBP changed the system of conducting OMOs in July 2001. As against the regular OMOs held every alternate Thursday, the State Bank started the new proactive method of calling OMOs at its discretion as a tool of short term liquidity management.
However, despite this new system the interbank money market witnessed volatile overnight rates with banks regularly visiting the discount window. Although the events of September 11 affected the liquidity of the money market as people resorted to hoarding money, OMO operations failed to overcome the liquidity crunch in the market. In this regard an active role is required to be played by the central bank in rectifying the unanticipated changes in market liquidity. Regular OMOs (may be more than once a day) with certain benchmark rates for calling an OMO might result in attaining the desired level of market liquidity.
Rising demand: After the SBP stopped issuing the long-term bonds (FIBs) in 1998, it started issuing new long-term securities (PIBs) in December 2000 to fill the vacuum. The aim was to provide institutional investors, especially pension and provident funds, insurance companies and corporate entities an avenue to invest their funds for a longer term after imposing a ban of investing in NSS (National Saving Schemes) in March 2000.
During the year 2001 (Jan-Dec), 7 PIB auctions were held. In April 2001, it was decided that the PIB auction will be held monthly whereby the auction of 3 and 5-year PIBs will be held in one month with 10-year bond auction in the subsequent month. The 7 auctions helped the government to raise Rs66bn in calendar year 2001 with a major chunk of Rs48bn coming from the 10-year PIB. Since its inception in December 2000 PIB has generated funds of Rs80bn uptill December 2001.
(The writer heads the research section at Invest Capital & Securities).