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  • Nov 14th, 2013
  • Comments Off on Further increase in next review highly probable
The central bank surprised the market yesterday by lower-than-expected increase of 50 basis points in the discount rate. This means one can expect a further hike in the upcoming reviews, owing to which the banks would likely keep investing in the 3-month paper, with little or no interest in longer tenures. Nonetheless, with the State Bank''''s downward revision in full-year inflation expectations, from 11-12 percent to 10.5-11.5 percent, may lower market expectation of full-year rate hike by the same proportion.

The central bank acknowledged better-than-expected fiscal performance and said that improved power situation had yielded some growth in exports and LSM. Nonetheless, the balance-of-payment vulnerability persists; financial inflows are low, and SBP reserves are down to $4.2 billion. In the absence of financial inflows, foreign exchange stability largely relies on exchange rates and interest rates. With exchange rate slipping by 7 percent in the first quarter, the onus lies more and more with interest rates. Thus, a further increase in policy rates in next review is highly probable.

In such a scenario, the money would keep on flowing into speculative activities and corporate treasuries would keep the cash and wait for higher rates before finding a safe haven for their surplus capital. The participation in NSS is abysmally low in the first quarter as savers are waiting for rates to peak. And not all is going in the bank deposits, as its stock is lower than what it was at the end of the last fiscal year. Thus, the financial markets are not lucrative enough to induce savings in rupee denomination. Remember, one of the biggest impediments to economic growth is widening gap in required investment and savings.

All this is not a good omen. A better strategy could have been to raise the rates in one go and let the market anchor on those rates for rest of the year. The counter argument to this view is that higher hike builds expectation of further increase. The best move to be out of this vicious cycle is to abandon the practice of bimonthly announcement of monetary policy and revert to the old format of six monthly releases. The bimonthly MPS was started at the time of volatile global economic scenario in FY09; but now the economic movements have smoothened world over and there is no need to review MPS too frequently. Plus, the SBP will always have the option to make an emergency announcement, as and when it deems appropriate.

Had the SBP increased policy rates by 150 bps in one go for six months market participants would have investment in for longer term papers. That would have helped in developing a long term yield curve which is quite erratic now. Having a policy rate of 10 percent and 10-year paper at 13 percent is a rarity and in many economies interest rates move in a much narrower band. Nonetheless, there are other impediments to the building of yield curve, such as allowance of institutional investors in the NSS as when the latter avenue is available to insurance companies, pension funds etc; only the commercial banks are left to price the PIBs. Economic managers ought to think on those lines to bring financial stability in the country.

Copyright Business Recorder, 2013


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