Markets after policy rate cut
Benchmark Karachi interbank offered rates slipped more than a full percentage point after the State Bank of Pakistan cut its main interest rate by 150 basis points to 10.5 per cent from August 13.
Yields on treasury bills also declined in secondary market—and overnight lending rates crashed.
This was bound to happen as the central bank had slashed its policy rate after ten long months by a higher margin than most financial analysts had guessed.
One important aspect of the latest rate cut is that it did not trigger any panic buying of the dollar in interbank or open currency market. “One big reason was that the rate cut was announced after we’d got $1.18 billion from the US on account of Coalition Support Fund. The market was pretty sure that after the reopening of the NATO supply lines, we’d be somewhat comfortable with external account. Besides, home remittances inflows are strong ahead of Eid,” said chief foreign exchange dealer at a local commercial bank.
THE policy rate cut brought about a 150 basis points increase in the KSE 100-index. That the stock market was happy with the SBP decision to go for a real rate slashing rather than an insignificant cut was evident from the market behaviour.
Turnover volumes at KSE shot up five times on August 13 over the August 10 levels and investors traded generously in shares of almost all key sectors except for, quite understandably, banking sector. Local companies bought stocks worth equal to $2.73 million and foreign investors’ buying was worth $0.88 million.
“The timing of the SBP action is such that the cost of government borrowing would fall substantially,” said treasurer of a leading commercial bank. “During the first quarter (July-September) the government intends to borrow more from banks than from the central bank because private sector normally retires bank loans during this quarter. A policy rate cut in the mid of first quarter will definitely lower the cost of the government borrowing immensely.” After the August 13 rate cut, the banker pointed out that the government intends to borrow Rs700 billion from banks till the end of September. This borrowing requirement is on gross basis i.e. the bulk of the amount to be borrowed through T-bills would be used to finance the T-bills that would be maturing during this quarter.
“But even then the replacement of expensive loans (obtained previously with higher returns on T/Bs) with cheaper loans means a reduction in the accumulated cost of internal debt which, by extension, is a fiscal relief,” says an official in National Bank of Pakistan’s treasury.
The policy rate cut, widely hailed by the private sector, will also make private loans less expensive. But that depends on how quickly banks readjust lending rates.
The current monetary policy statement (MPS) is unique in that it has exposed the otherwise misleading data on private sector credit off-take in the last fiscal year. The MPS points out that the bulk of growth in private sector lending of banks (Rs235bn against that of Rs121bn in FY11) was because of massive lending to non-bank financial institutions or NBFIs. It has also revealed that NBFIs were borrowing excessively from banks mainly to invest the borrowed money in government securities.
Now this being the situation the banks would obviously take time in changing course. “Expecting them to expand private sector lending overnight and at low interest rates is like telling them to part with their profits. That’s not the way banks work,” says head of private local bank. “With KIBOR of all tenures down, all private sector loans that are on floating rates anchored on KIBOR would come down almost automatically. But in pricing new private loans, the issue of fixing the premium over the benchmark rate would remain. We do not and cannot lend to private businesses at, say one percentage point over six-month KIBOR, if we know that the borrowers have a poor repayment track record or the kind of business they are doing is facing serious risks.”
Here lies the crux of the problem. Businesses have been justified in their demand for cut in interest rates because not only banks’ lending rates were high but banks were also overly cautious in making new loans. Their stance was that interest rates were very high only for inefficient businesses and that there were also borrowers that were denied lending because they lacked repaying capacity.
“But I tell you honestly that in last three years banks made very limited new loans simply because they knew that they could park funds in government securities as the government’s appetite for borrowing grew,” insisted a former vice-president of the Federation of Pakistan Chambers of Commerce and Industry.
“The result is before our eyes. Manufacturing sector growth is just above one per cent. Exporting goods at competitive rates got next to impossible and export earnings declined; and due to slower expansion in private sector enterprises, the economy suffered.”
Central bankers say that a 150-basis points cut in the SBP policy rate is enough to trigger a cycle of faster lending to private sector because banks sitting on piles of cash would not be able to use that for frequent employment in treasury bills as the rates on the bills have already come down.
“Moreover, with the reduction in our policy rate, banks can now park overnight funds with us at just 7.5 per cent. Do you think banks would risk amassing cash piles instead of lending to the private sector only to know at the end of the day that these funds can earn no more than 7.5 per cent if they park them with the central bank,” remarked a central banker.
So it seems that private sector lending of banks would expand in volumes and would become less expensive in due course of time. Executives of non-bank financial institutions also say that unlike in the previous fiscal year they cannot borrow excessively from banks to use that money for investing in government securities.
“The reason is T-bills rates have started falling in a big way and secondly, there are indications that government borrowing from banks would remain limited this year as overdue foreign money has begun to come into the system,” explained an executive of a local insurance company.