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The fiscal deficit is slipping fast amidst drying fiscal financing options for the government. Government cash deposits are thinning – reduced to Rs508 billion as of 16th April against Rs1,478 billion as of 18th February. In this situation – and given no option of direct borrowing from SBP (even the outright purchase by SBP in the secondary market is a no-go area from IMF’s lens), it’s a lender’s market. And they are milking the opportunity while government and SBP stand by as mere spectators.

That is why 6M T-bill yield reached 15 percent in the last cut-off, as the government is buying well over the maturity and even higher than the target. Moreover, the new government (just like every new government did in the past) has exposed the fiscal weaknesses, making the market demand more.

The question is how and when the market shall normalize. The question is whether the rates have peaked or not. These are difficult questions, and the situation is fluid. All expectations are becoming irrational and those who bought papers at lower rates in anticipation are now counting mark to market losses. Now some fund managers didn’t even bid in this auction as they were caught bewildered.

The root cause is commodity super cycle and more importantly government’s decision to not pass on the impact of higher fuel prices to consumers – in petroleum, electricity, and gas. The gaps are widening. The political uncertainty has served as a cherry on top. And one of the reasons to not pass on the price increase by the PTI government (and now increasingly by PDM) is to avoid the backlash of respective opposition –both got cold feet. Political rhetoric always has some economic cost; but politicians (on both sides) seem not to realize how close the country is to a default and how painful this could be for the people of Pakistan.

The government is not increasing the petroleum and other energy prices to avoid the inflationary impact. But it has failed to realize that the subsidy is being extended on borrowed money which will bring the inflation home as well. The partial equilibrium is not enough. And the market rates are already moving up.

However, the inflation may not average at 15+ percent in the next 12 months; but is likely to cross 15 percent for the next few months before finally cooling off. The rates aren’t just increased to counter inflation, but must also price in default risks, as virtually all government borrowing relies on banking sources.

SBP has been doing open market operations (OMO) injections for a long time and that has crossed Rs3 trillion. There is no inherent limitation on OMOs. However, banks have exhausted their internally assigned credit limits, and seeing the mark-to-market losses, they are bidding even higher, while the government has no choice but to accept.

This situation must be handled with coordination and delicacy. SBP and debt office at MoF are clearly not in sync at the moment. SBP should issue 2M OMOs to calm the markets. But again, some took two months OMO few months back and invested in 12M papers and are now counting losses. Even so, it would be enough to lure many to park in 3M at lower rates.

Moreover, the finance minister and SBP should bring the banks on table and explain to them their financing needs and ask them to agree on certain rates for investing Rs2-3 trillion (below 14 percent). The ex-finance minister used the term kunda (in Punjabi style) for banks - hinting at possible collusion. Now, Miftah can use his softer Gujrati touch to do the same.

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