KARACHI, Jan 5: The State Bank on Wednesday raised the weighed average yield on six month treasury bills to 4.16 per cent, which means that exporters will get export loans at 5.5 per cent in February. But they will continue to get such loans at 5 per cent during this month.

The central bank increased the average yield on six-month bills by 43 basis points -- and also sold more bills than targeted to increase the yield to this level -- just to signal to the financial market that faster tightening of interest rates are on the cards.

Accelerated tightening of interest rates is required to check inflation that increased by 9.1 per cent year-on-year in July-November 2004 against the full fiscal year target of 5 per cent.

The State Bank estimates that inflation may settle around 7.6-8.2 per cent in the current fiscal year whereas the economy can grow by 6.5-7.1 per cent against the target of 6.6 per cent.

But the government officials say inflation would just touch 7 per cent mark -- and that too in case the economy grows faster than the targeted pace of 6.6 per cent.

Bankers said the central bank sold Rs27.45 billion T-bills, almost three times the sale target of Rs10 billion to raise the average yield to 4.16 per cent up from 3.73 per cent in November.

The SBP increased the six-month T-bills yield by such a wide margin after scrapping their auction last month to avoid the same. Had the central bank let the yield rise past 4 per cent in December, export finance rate for January would have risen to 5.5 per cent.

Apparently the central bank did not want to do that as the export finance rate had already gone up to 5 per cent in December from 3.5 per cent in June last year.

When the central bank increases the yield on six-month treasury bills this pushes up the export finance rate for the next month because the later is indirectly tied with the former.

While increasing the weighted average yield on six-month bills to 4.16 per cent, the central bank has allowed the cut-off or maximum yield to rise to 4.32 per cent, up from 3.84 per cent in November.

This 48 basis points increase in the cut-off yield means the cost of borrowing would go up for a large number of corporate and commercial clients of banks whose financing facilities are based on floating interest rates with six-month bills serving as benchmark.

Since the start of the new fiscal year in July, the SBP has so far jacked up the average yield on six-month bills by 2.09 percentage points. It has also increased the average yield on three-month and one-year bills by 2.22 percentage points and 2.10 percentage points respectively.

The SBP has undertaken this tightening of interest rates to fight inflation but despite that weighted average lending rate of the banks is still negative i.e. it is lower than inflation. This calls for further tightening of interest rates, which seems now to be on the cards.

Weighted average lending rate of all the banks combined stood at 6.61 per cent at end-November 2004, according to provisional data released by the State Bank. Year-on-year inflation during that month was 9.26 per cent.

So, the average lending rate was 2.65 percentage points lower than inflation. Keeping real lending rate or the lending rate minus inflation negative encourages hoarding of commodities, unnecessary inventory building and speculation in almost all spheres of investment including non-documented sectors. That, in turn, fuels inflation further.