The State Bank of Pakistan (SBP) injected liquidity of Rs1.7 trillion, including Rs689 billion for a rare 63-day period at 9.9 per cent and Rs1.09tn for the usual seven days at 9.82pc, through its open market operations (injection) last week to clear uncertainty about monetary tightening and inspire confidence in the market that it is not going to raise the interest rate at least until March.

The analysts believe that the central bank had conducted the 63-day OMO injection to bring stability to the money market and assure commercial banks that the new monetary tightening cycle, which started with a small bump of 25 basis points in the key policy rate in September followed by 150bps increase in November and 100 bps hike last week, is over at least for the immediate term.

The issuance of longer-term maturity OMO will reduce the commercial banks’ repricing risk for more than one and a half months, which will help bring down the cut off yields in the next T-bill auction later this month.

The SBP needs to restore the credibility of its monetary policy statements by not creating uncertainty in the markets or surprising them with sudden shifts in its forward guidance

The SBP, like other central banks, often conducts OMO to inject liquidity into or mop up excess money supply from the market to manipulate the interest rates in line with its monetary policy objectives. Normally, the OMOs are for shorter tenors ranging between seven days and 14 days. But last Friday’s OMO injection was the largest maturity cycle ever. The previous high was 17 days back in August 2011, according to Topline Securities.

“This would signal to the market that the central bank is willing to accept a fixed cost for two months, which means that the policy rate will remain unchanged in the near term,” Fahad Rauf, head of research at Ismail Iqbal Securities, says.

“This action has likely come in reaction to higher cut-off yields in the T-bill auctions (held on December 1 and 15) and should bring down rates in the next auction later this month (when the government returns to the market to raise funds amounting to Rs1.2tr),” he continues.

There are two plausible explanations for the much higher-than-usual premium charged by the commercial banks in the last two T-bill auctions. One, the demand and supply factor might be in play as the government has no choice but to look towards the commercial banks for meeting its borrowing needs ever since the International Monetary Fund (IMF) stopped the SBP from financing the budget deficit under its 2019 funding programme.

The other reason of course pertains to the central bank’s November monetary policy decision to suddenly hike the rate by 150bps, ditching its previous forward guidance of ‘gradual and measured’ tapering of monetary stimulus in response to the rising inflation and the widening current account imbalance.

The bankers were anticipating a further increase in the interest rates in the near term contrary to the assurance given by the SBP

The monetary policy statement in November clearly indicated the continuation of monetary tightening but didn’t revise its inflation projections of 7-9pc and the current account deficit estimates of 2-3pc of GDP or $6bn-9bn for the present financial year. That created uncertainty in the market, especially in the wake of the staff-level agreement with the IMF for the resumption of its $6bn funding programme. The IMF funding is, however, contingent upon the execution of five prior actions that include an increase in taxes, cut in development expenditure, reversal of the Covid-related monetary stimulus and SBP autonomy.

So it wasn’t surprising to see the commercial banks charging big premiums on T-bills on December 1, exploiting both the demand-supply factors as well as interest rate uncertainty. What surprised the market watchers was their response to the central bank’s new forward guidance in its latest monetary policy that tried to clear uncertainty in the market, suggesting that the latest round of monetary tightening was over for the moment after a hike of 100bps in the key policy rate to 9.75pc.

It said the “end goal of mildly positive real interest rates on a forward-looking basis was now close to being achieved... (and it) expects monetary policy settings to remain broadly unchanged in the near-term.” The SBP also revised upwards its inflation projections to 9pc-11pc and the current account gap to 4pc of GDP.

The bankers also ignored the central bank’s warning in its recent monetary policy statement, terming the rise in the secondary market yields, benchmark rates and cut-off rates across all tenors in the government’s auctions as unwarranted. In spite of these developments, the yields in the last T-bill auction held a day after the announcment of the monetary policy remained flat at the same level from the previous auction while in the secondary markets it went up by 20bps to 30bps.

That implied that the bankers were anticipating a further increase in the interest rates in the near term contrary to the assurance given by the SBP.

Analysts agree that the SBP’s OMO injections will also help the central bank set the direction of interest rates. But, as pointed out by the Topline analysts, the overall economic numbers, especially the Consumer Price Index, current account deficit, foreign exchange reserves along with the timing of the resumption of the IMF programme, will remain the key determinant of the interest rate movement going forward.

More than that, the SBP needs to restore the credibility of its monetary policy statements by not creating uncertainty in the markets or surprising them with sudden shifts in its ‘forward guidance’.

Published in Dawn, The Business and Finance Weekly, December 20th, 2021