T-bill: far from a runaway success

Hammered by a lower liquidity level in the market, the participation in the Treasury bill auction held last week stayed below the governments pre-auction target level.
With a total participation level of around Rs97 billion, the auction drew a participation to pre-auction target ratio of 0.8. However the average participation to target ratio stood around 1.8 for all auctions held in 3QFY12.
The combination of a high budget deficit and drying external flows has heightened the pressure on domestic borrowing avenues, thereby, damaging the liquidity level in the market.
The governments reliance on the banking sector can be gauged from the fact that the scheduled banks outstanding credit (net) to the government sector reached close to Rs2413 billion by the end of February, 2012, nearly Rs588 billion higher compared to outstanding debt at the end of FY11.
Moreover, scheduled banks were holding nearly 72 percent of the total outstanding sovereign instruments: Treasury bills, PIBs and Sukuk Ijara as on February 29, 2012.
Another main jarring note is the government reliance on borrowing from the State Bank of Pakistan, since the central banks credit to the government sector increased by around Rs210 billion during the first eight month of FY12 to Rs1395 billion at the end of February, 2012.
On the heels of uncertain interest rate outlook, the participation remains concentrated in shorter tenure papers. Participation in 3-month and 6-month papers alone accounted for 95 percent of the total participation, largely indicating the market perception that the interest rate has bottomed out.
The government has managed to check growth in inflationary pressure, but high current account deficit level, rise in energy costs and possible threats that oil price might increase in the future. Payments to IMF point towards rising inflationary pressure down the line as well.
The average inflation has hovered around 10.8 percent during the first eight months of FY12, as opposed to the average of 14.07 percent during same period last year.
However, the cash starved government raised a total of Rs57 billion in the auction, nearly Rs67 billion shy of pre-auction target level. While the cut-off yields on 3-month and 6-month paper inched up by 5 bps and 4 bps, respectively, relative to the previous auction.
With declining foreign inflows, the government will continue to rely on the banking industry to fund its deficits. This will, in turn, increase the bargaining power of the lenders to demand higher yields on sovereign instruments.