Money market – government blinked

The cat and mouse game was going on between the government debt office and bond/money market participants. It was only a matter of who would blink first. Government did. Both in bond and short term paper markets. Since October 2020, government was rejecting bids of 5Y and 10Y bonds. The participation in T-Bills market was low beyond 3M papers and government was not even accepting these. The government wanted rates to be lower; but market was not participating at desired rates. The activity mainly remained confined to 3M papers.

However, in latest auctions of both PIBs and T-Bills, government did accept offered amounts at higher rates, although the participation was still low. One reason could be that since government was not interested, market wasn’t bidding. Now with government signaling a new acceptance, there is fair chance that market would participate more around new cut-off yields. The good omen is that yield curve, which was broken, now has some activity at each pocket. Something dearly desired by both the SBP and the IMF.

The price discovery was not taking place. The market was squeezing to 3M-papers and not keen on bidding beyond. In seven previous auctions (prior to 27th Jan), on average 93 percent of participation was in 3M papers. On 22nd January 2021, SBP gave forward guidance of continuing with accommodative monetary policy for the first time in history. The participation in 27th Jan auction was 83 percent in 3M paper. Still too high; but better than earlier.

Some are confusing forward guidance with market rates. The SBP gave a direction on anchor rate. The T-bills auction rates are determined by the market. In well-functioning markets, there should be participation at every pocket to ensure price discovery which builds yield curve. Without any activity, there is no effective yield curve. The SBP has given forward direction and government is accepting market offering. Now the price discovery could be much better.

That is shiny side of the ball. Rough side is reversing the swing. There might be some tampering.

Core of the problem is high and growing government debt. The fiscal deficit is not in control. The external avenues to finance are drying up (no international bond/Sukuk issuance in sight). Government cannot borrow from the SBP under the IMF. The insurance, pension funds and other markets are thin. The growing need of fiscal financing is on banks – mainly conventional banks – as Sukuk issuance are limited (if government tries to issue one, social media worries create frictions). Almost 72 percent of PIBs and 79 percent of T-Bills – marketable securities, are held by conventional commercial banks.

The money market shows system liquidity is not enough to cater to banks’ need – mainly to lend to the government. The SBP is injecting through reverse open market operations. The outstanding quantum is over Rs1 trillion. It is a buyer (bankers) market. Hence, seller (government) had to blink.

The thinking in Islamabad is probably around working on targets. Comply with the targets with aim to have balanced acceptance across tenors. For that, banks must participate in all pockets. Government is giving them an option. Banks are now in the driving seat. But banks should not be greedy; otherwise, government could go back to accepting short term papers. Rates are good now; pundits expect balanced participation in the coming auctions.