Ali Khizar
It’s a feel good factor! The business sentiment is improving but has not yet starting translating into investment. SBP in its monetary policy decision has attempted to restore the businessmen’s confidence by aggressively and intelligently easing the monetary stance. But there is not much that the central bank can do at a time of severe supply side constraints.
Nonetheless, it is a step in the right direction. SBP beat market expectations by cutting the policy rate by 100 bps to seven percent – the lowest in 42 years. According to a survey conducted by BR Research only four out of 20 research houses were expecting 100 bps cut while rest thought it to be 50 bps.
However, the secondary market yields have already priced in a steep cut. The T-bill yields were around 6.8 percent in the last auction and 6M-KiBOR offer rate was 7.08 percent on the last working day while the open market repo rate was around 7.3 percent. The market rates were much less than the prevailing policy rate which was at eight percent.
Due to the anticipation of further rate cut, there were, in the market rates lower than the policy rate and affectively were benchmarking overnight rates. IMF wanted overnight rate to be set as the target rate and it was expected that SBP might have done that in the March policy decision which it did not. This time it has done so and set a new ‘SBP target rate’ at 50 bps below the ceiling rate (policy rate). Thus, the target rate will be the main policy rate and SBP will ensure that overnight rates remain close to it.
The reason for having this target rate is to reduce the volatility in interest rates with an objective to hover around the middle of the interest rate corridor. Another step taken to ensure this is the reduction of the width of the corridor by 50 bps to 200 bps. This means the floor of the interest rates will now be at five percent instead of 5.5 percent in the previous policy decision.
This will further squeeze the banking spreads as the minimum saving rate is set at 50 bps below the floor. The floor is down by 50 bps while the ceiling has been cut by 100 bps. The lending rates are benchmarked at KIBOR and that is linked to overnight rate which will remain close to the new target rate set at 50 bps below the policy rate.
The overnight rate was already below the policy rates for a last few months, so the spreads were already squeezing, but lowering the floor by lesser margin will further tighten banks’ margins. However, the 6M-KIBOR offer rate will not come down as much as the benchmark rates is lowered – it is likely to hover around 6.5 percent from existing 7.08 percent as market may not expect further easing anytime soon.
It’s a brave decision of shrinking the corridor and certainly in the right direction. Commercial banks had a bonanza in the last year or so, by having loads of money (over RS2.5 trillion) invested in the PIBs at the time when interest rates were expected to come down.
The benefit will remain to be accrued on 3-year paper most of which are maturing in July 2016. But the brunt of squeezing margins will be felt in profitability, especially in 2016 and government may lose some tax revenues as well. But that is fine as far as it compels banks to go for lending to private sector for maintaining high returns on equity. This may lift up a bit of private sector credit and domestic investment. While not letting deposits rates to fall by same the magnitude, the national savings may improve as well.
The message is for banks to do what their mandate is i.e. to channel the savings into investment and do away from lazy habits of relying on government papers to mint money. But we have to carefully examine the bankers’ worse experience of toxic loans last time when they aggressively lent to the private sector. Poor recovery laws incentivized private players to default without banks fully utilizing collaterals. The bankruptcy and recovery laws improvement and its enforcement; is imperative for any real pick up in private credit supply.
Plus, the energy deficit is discouraging fresh investment by domestic players and hindering the demand of private credit to boost. The two projects by public sector (Punjab government’s LNG plant WAPDA’s Dashu Dam) are looking for Rs200 billions of loans from banks – what would be left with banks for the private sector after lending for government’s mega project.
But not is in the hands of SBP, the institution is doing what it can to spur some growth or, at least, improve the sentiments. The fiscal deficit has to be lowered and its financing reliance has to move from commercial banks to provide space for the credit which has not picked up so far this year despite easing mode.
