BMA-PGBI Monthly: largest single-day drop in BMA-PGBI witnessed following SBP's hike in discount rate to 9 percent

BMA-PGBI yield up by 165 bps: April, 11 2005 witnessed the long expected discount rate hike of 150 basis points (bps) from 7.5% to 9.0%. This resulted in another month of extreme volatility and sell off in Pakistan's bond markets. As shown in Figure 1, the BMA-PGBI (total return index) was down by 499 basis points or 5.0% month on month to close at 94.27 and BMA-PGBI yield was up by 165bps. Yield changes have been observed across the curve, with a maximum rise of 197 bps in 10-year bond, while the average change in PKRV yield was about 177 bps as shown in figure 2. (All figures as of May 02, 2005).
Short-end of the yield curve outperformed: Negative returns ruled during April 2005, however, the short end of the curve outperformed. Cautious investors who stayed away from long bonds were the winners during April. Although gross returns suffered across all tenors, the maximum hit were taken by long bond holders where gross returns were as low as negative 11.0% as shown in figure 3.
Selling volume outweighed buying volume and even corporate buyers remained on the sidelines waiting for the right opportunity to buy. Greater selling pressure resulted in sharp yield changes across the curve.
With this back drop, the BMA-PGBI posted high volatility during April. Annualised volatility on returns was 7.6% during April compared to 1.06% during March 2005. A total of 10 coupons were received during this month which amounted to Rs 105 million as compared to Rs 10 million during March. The coupon effect on the
BMA PGBI is marginal as compared to the price effect.
SBP measures signalling active monetary management to curb inflation: Of the three tools of monetary management at SBP's disposal, the first tool, a change in discount rate, sent a clear signal from the SBP reinforcing its intention to curb inflationary pressures in the economy. The BMA-PGBI declined by 2.0% to 97.5403 on April 11, 2005 which is the single largest single day decline since the inception of the BMA PGBI on 1 January, 2004.
The second tool used by the SBP was to increase the Treasury bill cut off rates. SBP mopped up PKR100bn against a target of PKR70bn on April 13, 2005 for 3 month and 12 month Treasury bill auction. The 3 month T-Bill yield increased by 130 bps from its last cut-off to 6.39% and 12 month T bill increased by 138 bps from its last cut-off to 7.25%. In response to these market changes the BMA-PGBI shed another 1.5% to close at 96.0639 on April 13, 2005.
Apart from this, the SBP also raised the cut-off yield for 6 month T bill auction by 150 bps to 7.1877% and realised an amount of Rs 7.881b against a target of Rs 20.0b on April 27, 2005. The BMA-PGBI went down by 0.7% to close at 95.9640.
Investment perspective: Our expectation is for the 10-year PIB yield to go beyond 11.0% from current levels of 10.40%. There is much talk of the SBP increasing the statutory reserve requirement from the current base of 5.0% to 7.0%. Whether the SBP eventually decides to do this or not will largely depend on how successful it sees its previous attempts to rein in inflation and also credit growth in the banking sector.
What is clear is that expectations of a change in the statutory reserve requirement and a further hike in the discount rate will undoubtedly have a negative impact on short term bond prices and bearish sentiment is likely to prevail.
Moreover, PIB's were last issued in May 2004 and since then all PIB auctions have been rejected. Should the Government of Pakistan borrow through PIB's at this stage, another fast and sharp rise in bond yields can be expected.
One of the key questions now is, how soon can the SBP signal some degree of stability in bond yields at near current levels. Should the 10 year PIB yield remain positive in real terms until 3Q/2005, we could anticipate such a signal. What is clear at this stage is that any signal to this effect should help alleviate fears of a sustained rise in long bond yields.
Result: a greater level of institutional demand for long bonds in the short term and overall stability in market yields moving forward at the short and long end of the yield curve.