THE resignation of SBP Governor Dr Shahid H. Kardar due to government intervention in monetary management is a reality check for many in the banking business.

“It has confirmed our worst fears that the SBP’s stance on the changes required in its key policy rate often remains deceptive,” said head of a foreign bank. He stated that when the central bank announced to keep its policy rate unchanged in its end-May review of monetary policy, “several banks had doubts whether the decision was prudent.”

A monetary management committee, comprising senior central bankers, recommends change in the policy rate after every two months and the SBP’s board of directors makes a final decision.

“What makes it easier for the government to dissuade us from raising the policy rate by the required margin is that the law (that governs the central bank affairs) requires us to keep a balance between inflation and economic growth,” revealed a senior SBP official. “Unless we change that particular provision of the law and move towards inflation targeting there will always be room for government intervention.”

A top businessman having links with policymakers in Islamabad said, the recent SBP decision to increase re-finance rates on long-term financing of industries had upset the powerful business lobbies. “Top government officials wanted the SBP to reverse the decision to appease businessmen but the central bank refused to do so.”

Even before that excessive government borrowing from the central bank (or printing of currency notes) had become a bone of contention between the ministry of finance and the SBP.

“Here again, the issue is that under the law the central bank cannot “stop” the government from borrowing from the SBP. The law does require the government to seek the SBP’s consent but it does not give us powers to actually “stop” government borrowings,” pointed out a senior SBP official.

He said the recent changes made in the SBP Act were not adequate enough to really make the central bank the sole authority for deciding all monetary matters. “That’s why you see all this chaos. We need to do some basic legal work on resetting the terms of fiscal and monetary coordination.”

Meanwhile, during the week that ended on July 15, the government borrowed Rs116 billion from banks, corporates and high net worth individuals through treasury bills. The weighted average yield on three-month and six-month bills gained two basis points each whereas the rate on one-year bills remained unchanged. A foreign bank treasurer said that with average CPI inflation hovering around 14 per cent banks were anticipating a bit of tightening in the monetary policy towards the end of this month.

He said that the market was also anticipating larger government borrowings from banks in coming months as the government is under pressure to reduce its most-inflationary borrowings from the central bank. “These are two basic reasons why bids for T-bills remain pricy.” But treasurer of a large local bank said “scant liquidity is forcing banks to demand higher yields on treasury bills.”

Senior bankers say, private sector credit expansion was modest in the last fiscal year mainly because of low demand from industrial sector but excessive government borrowing also crowded out the private sector to some extent.

Large scale manufacturing grew just 1.33 per cent in 11 months to May 2011 and output in May alone rather fell 2.28 per cent, primarily due to power shortages.

“However, right now we are witnessing some expansion in private sector credit on the eve of cotton financing season and because private sector activities are picking up ahead of Ramadan,” said head of corporate credit of a local bank. He said that as credit retirement had slowed down after June, this too should keep net private sector lending on the higher side during the current quarter.

Head of consumer credit at a local bank said personal and auto financing has started showing signs of a modest growth ahead of Ramadan adding that it would pick up further pace, two or three weeks before Eid.

Foreign exchange dealers said that the rupee lost 17 paisa to the dollar during the week to July 15 because as banks covered their positions after a scheduled external debt payment. Foreign exchange reserves also fell about $140 million in the process. “But this depreciation of the local currency was more of a recovery of the dollar that had lost 13 paisa to the rupee a week earlier,” remarked chief forex dealer at a local bank.