Rise in market rates: is the SBP losing credibility? – BR Search


The market has once again made the policy rate irrelevant. The threshold of the last auction of Treasury bills reached 15.25% for 3M and 15.5% for 12M while the key rate is 13.75%. These high rates were the case in the 1990s. Rates did not reach this level in 2008-09, when headline inflation peaked at 25% and reached an annual average of 21%. Today, inflation is expected around 15% (peaking at 20%) for FY23 and the latest reading is below 14%.

In its latest monetary policy statement, the SBP took note of the misalignment of the policy rate and the threshold rates and warned of appropriate measures in case of misalignment. It did the same by issuing 63-day open market operations (OMOs); yet the market is not listening. Is the SBP losing its credibility and losing control of monetary policy?

The problem is that the government wants as much money as it can to fund its growing financing needs (due to energy subsidies) while the banks are unwilling to lend. The external paths are practically blocked without the IMF. The growth of currency in circulation (CIC) is undeniable. SBP lacks innovation (or out-of-the-box thinking) to bring rates back into the box.

SBP blames it on budget slippages. Yes, there is no doubt about the tax gap. But the crisis is also that of the balance of payments. And the twin deficits in terms of GDP were also high in 2008-09. Inflation was higher. Still, market rates were under control. Now things are not working at all according to SBP’s plans.

There are some things SBP can handle, like outright buying papers on the secondary market and efforts to reduce the currency in circulation. However, all SBP does is offer longer term OMOs and word warnings. Action speaks louder than words. The market needs serious actions to restore the authority of the institution.

Banks want to get away from government papers. How many OMOs can they have on their books? The balance of the injection of OMO (conventional and sharia) amounts to 4,000 billion rupees (25% of bank deposits). The banks seem to be done with this exposure. They have concerns for their own balance sheets. Are there no other funding opportunities available?

Why isn’t SBP doing anything concrete to bring CIC back to normal? The CIC/M2 ratio is currently 30% compared to 22% ten years ago. Reducing the CIC to 22% can increase bank deposits by 2 trillion rupees. Even a fraction of that can drive market rates down significantly.

Second, the amended SBP law allows the central bank to buy purely and simply on the secondary market. There is a problem of definition with the IMF on this subject. Can’t SBP solve this problem? Can’t the bank negotiate this with the IMF? These are not tax issues. This is a matter that needs to be addressed by the SBP.

Anyway, the situation on the ground is that the government raised Rs 751 billion in the auction against the target of Rs 750 billion. Mainly, the amount is raised in 3M where 556 billion rupees are raised at 15.25% and the rest is distributed in 6M and 12M papers.

The only hope that market rates stabilize or fall is the agreement with the IMF and for that the government must take tough measures. SBP’s assumptions regarding future directions and deviations are based on the reinstatement of the IMF program. There is no contingency plan (at first sight) available to SBP or the government. And this makes the market nervous and will remain so until the IMF returns or until measures are taken (beyond 63 days of OMO) to improve the liquidity of the system.


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