THE last fiscal year was marked by a significant structural change in the ownership of government securities as the policymakers struggled to diversify the sources of budgetary financing.

According to the latest SBP data, some 59 per cent of all investment in long-term Pakistan Investment Bonds was made by non-bank entities as of end-May 2011.

Similarly, corporates and individuals held 25 per cent of all investment in treasury bills whereas the share of non-bank institutions (insurance companies, funds and corporates etc) stood at nine per cent in domestic debt raised through Ijara Sukuk or Islamic bonds.

The government decision taken last fiscal year to allow individuals to invest in treasury bills has helped the government borrow more from the market at desirable rates. But, so far, banks have not advertised this scheme widely and only high net worth individuals which include bankers, fund managers, some media tycoons and top professionals, are reported to have benefited from this scheme.

Meanwhile, the benchmark interest rates moved upwards during the last fiscal year as the State Bank of Pakistan spiked its key policy rate in the battle to contain surge in inflation. The central bank raised the reverse repo rate from 12.5 per cent to 14 per cent in three equal installments. Simultaneously it also increased its repo rate from 9.5 per cent to 11 per cent.

Benchmark KIBOR of various tenures recorded a rise that matched closely with the cumulative increase of 150 basis points in SBP policy rate. And banks' fresh average lending rate gained just 99 basis points in eleven months to May 2011 (see table).

“This points to an improved transmission of monetary policy signals. And it shows that policy rate changes were well-timed and our actions in interbank market were well-aligned” said a senior SBP official.

He said the introduction of interest rates corridor back in 2009 played an important role in it.

In August 2009 the SBP had, for the first time, permitted banks to surrender surplus funds to it in the same fashion as they borrow them from the SBP when they are short of funds. But the central bank decided to keep its reverse repo rate (or the rate at which it lends money to banks) three percentage points higher than its repo rate (or the rate at which banks were to lend surplus funds to SBP). The decision was aimed at ensuring that banks use the repo facility sparingly after exhausting all possibilities of employing surplus funds with their clients or within the interbank market.

Senior bankers said that in the last fiscal year they used this facility very occasionally. “Most of the time the market squared off liquidity levels and one bank's surplus was used to ease off temporary cash crunch of another bank,” said treasurer of a large local bank. “And the central bank also continued conducting open market operations somewhat more skillfully whenever the market had overall surplus or when a liquidity crunch became rather acute.”

Central bankers say that their well-timed OMOs also indirectly helped in keeping interest rates at the desired levels. “We used OMOs to suck in only that much liquidity which we thought had to be drained off. And we injected only as much liquidity as was required to help ease a crunch without unnecessarily depressing interest rates,” said a SBP official.

“We naturally went for the most appropriate tenure for which liquidity was to be pumped in or sucked out and we also looked for judicious cut-offs (the rates at which liquidity was added to the system or drained out of it.”

So, that was how the central bankers say they tried to navigate interest rate movements without losing sight of the basic objective of containing inflation.

But beyond that the SBP could not save the private sector from being crowded out by excessive government borrowings from banks though at times it did voice its concern on this issue. Federal government borrowing from banks in FY11 (up to June 25) totalled Rs548 billion—almost double of its borrowings in FY10. But banks' net lending to private sector was just Rs86 billion during the last fiscal year, slightly higher than Rs78 billion a year earlier.

Senior bankers confess that regardless of the crowding out phenomenon they themselves were shy of offering liberal financing to the private sector fearing a buildup in their bad loans. Moreover, the demand for private sector credit also did not show much growth. Higher commodity prices, instead, can be cited as a reason for a slight increase in private sector credit off-take.