In December, SBP conducted open market operations (OMOs) three times, which did not prove to be an effective monetary tool. With an average OMO injection of Rs 1.5 trillion this monetary tool becomes less effective. Money market traders pay no heed to it because of two factors. Since almost a decade, despite record low level of bank lending to the private sector, the SBP injects funds into the banking system by conducting regular fortnightly OMOs encouraging banks to buy the government paper.
The banks’ investment in the government paper floats around 78% of the total deposit. The normal size of T/bills fortnightly maturity and auction target ranges between Rs 500 billion and Rs 1.2 trillion.
Banks are aware of the fact that SBP or Ministry of Finance does not have any other option due to their commitment with the IMF or else the fiscal deficit target will shoot up and hence, they will not allow banks to lend funds to private sector, which is why banks are encouraged to invest in government securities.
But the impact has another negative aspect: the loan to deposit ratio has plunged to record low level below 50%, which goes unnoticed. To narrow the rate-yield gap, the formula is very simple and easy. SBP will have to use its monetary tool more efficiently by keeping the market liquid for some time until desired rates/yields are achieved.
It will have to widen the floor and ceiling level to 400 bps (basis points) from current 200 bps, which means current policy rate is 9.75%. Floor and Ceiling levels for the interest rate corridor should be 7.75% and 11.75% p.a., respectively (i.e. width of 400 bps). At the time of introduction of the corridor in August 2009, its width was 300 bps. Another option is to remove the floor, which may not be possible without the IMF nod, but it will work like magic.
SBP AUTONOMY/GOVERNMENT BORROWING
The government borrowing window is a key worrying factor under debate/discussion. This should not be a cause of concern as long as SBP open market open (OMO) window is not shut. Emergency borrowing of funds will be available in a crunch situation. For almost a decade through the OMOs, SBP has provided “Helicopter Money”. Hence at the time of emergency the window is available and active.
Sensing urgency in hope of autonomy, last month SBP effectively activated yet another window. It’s the Shariah-Compliant Standing Ceiling Facility and Open Market Operations (injection) for Islamic Banks. In future this window will be able to provide liquidity, which could replace borrowings from commercial banks.
The only issue that needs to be sorted out and hopefully will be arranged at the time of the funding need is the asset required to raise funding from Islamic banks. It is, however, not clear what types of assets the government can provide because as per past media reports quite a few important government assets are already pledged.
My best guess is that when and if needed, combined borrowing of Rs 5 to 6 trillion looks a good possibility in future, which will largely depend on government spending, deficit financing and tax collection. The largest injection through OMOs was of Rs 2.6 trillion on May 17, 2021.
EXCHANGE RATE
In present times, one of the most difficult things to discuss and predict in Pakistan is the exchange rate. We have a history of balance of payment problems that have never been addressed in the true sense of the word, which is why the IMF has been engaged on as many as 23 occasions. This is because for decades the trade gap has been widening constantly due to lower exports and higher imports, reaching an all-time high only recently. Even home remittances of $ 31 billion annually are not enough to bridge the gap and support the PKR.
The capping of PKR at 178.30 witnessed in December/21, which was historically the lowest ever traded level against USD in the interbank market. It is difficult to explain whether the currency is free float or fixed. But like the past, it was certainly very well managed.
Central Banks (CBs) globally adjust currencies according to their needs (demand and supply). It is neither fully fixed nor fully floated, every country manages its currency secretly. This is why CBs often show their concern when currency moves are extremely choppy. If the conditions are too volatile and breach desired levels, initially before aggressive intervention, a CB gives warning to the market players through verbal intervention and activates its monetary tool.
However, it is worth noting that rupee gained substantially during the IMF suspension period, hitting 152.25 in May 2021. Since the beginning of the new fiscal year, PKR started losing its gloss, the balance of payment pressure mounted as the trade gap began widening due to record imports while export growth was not enough to fill the gap.
As the country will be approaching the general election in the next fiscal year (FY23), which starts from July 1 2022, the fate of rupee will depend on government spending and its fiscal policy stance. Inflation has already skyrocketed and in the last quarter it averaged 11%. Remittance will continue to provide support and will not fall below $ 30 billion annually. Due to Carry Trade (interest differential advantage) by Pakistanis living abroad Roshan Digital Account (RDA) may soon get exhausted as a US rate hike could increase the cost of investors’ borrowings.
Ultimately, the trade gap and current account numbers will provide future rupee direction.
GOLD @ $ 1830 — Taper/Rate Hike does not support the metal. Monetary tightening is bad news for gold, as draining of liquidity and hike will encourage investors to shift their funds in US Dollar and other assets. Gold is likely to remain soft, a break of $ 1705 will encourage a test of $ 1620-40 zones. However, it needs to surpass $ 1890 for a test of $ 1940, which is not a preferred choice.
EURO @ 1.1340 — In Germany, a new government of 3-party coalition could face political risk. While FED’s tighter stance will strengthen USD and ECB’s easy policy approach is likely to weaken the European currency. Only a stable government and shift in ECB policy stance could change the weak Euro sentiment. Until then the upside should be capped around 1.1580-20. A push below 1.1120 will encourage a test and break of 1.0950-80 zones or a move towards 1.0750. Else 1.1780.
GBP @1.3505 — BREXIT concerns and political instability in the UK could weigh on Pound Sterling. It is expected to remain capped below 1.3750 for a move towards 1.3250. A break will open gates for 1.2950-80 zones. A fall will encourage 1.2650. Else 1.3880.
(Concluded)
(The writer is former Country Treasurer of Chase Manhattan Bank. The views expressed in this article are not necessarily those of the newspaper)
He tweets @asadcmka
Copyright Business Recorder, 2022
(The writer is former Country Treasurer of Chase Manhattan Bank. The views expressed in this article are not necessarily those of the newspaper)
He tweets @asadcmka
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