ISLAMABAD (November 18 2002) : The decision to cut the discount rate by 1.5 percent, taken by the State Bank of Pakistan, after bringing the International Monetary Fund on board, is aimed to protect the Federal Budget and SBP's own depleting reserves. It would have very little impact on lending rates to the private sector but would definitely impact the profitability of commercial banks, according to highly placed sources in the capital.
SBP was projected to provide Rs 26 billion from its profit in FY03 to the federal budget. With just four and a half months into the financial year, the net transfer from its profit to the budget is now being estimated at Rs 7 billion only, and the IMF was told on Saturday that Rs 13 billion would be SBP's contribution in the current budget–with Rs 6 billion coming from its own reserves.
For the last two years SBP has been drawing on its reserves to contain the federal fiscal deficit. Its Central Board of Directors, while approving the accounts for 2001-2002, has cautioned against this policy and has ruled that prior permission must be sought from the Board before transferring funds from the reserves of the bank to the federal government.
The slash in the discount rate to 7.5 percent will now be followed up with a lowering of yields on Treasury Bills and Pakistan Investment Bonds. Traditionally, there has been a 1.5 to 2.0 percent gap between the discount rate and yields on government paper. With discount rate at nine percent and T-bills yields at 6.3 percent the gap had increased to 2.7 percent. Senior bankers now expect the six-month T-bill rate to drop by 1.25 percent in the next auction.
The Federal Finance Minister, Shaukat Aziz, has been publicly calling for lending rates to be reduced to single digit. But SBP, for over four months, has been resisting this on the ground that 15 percent money growth due to higher inflows of foreign exchange would have an inflationary impact and the CPI monthly trend was already showing an increase.
Secondly, SBP has been aggressively buying dollars in order to contain appreciation of the rupee against the dollar to help exporters maintain their market share despite unit prices coming down due to the economic slow-down in the developed economies, by keeping the rupee under-valued.
The market for a long time had believed that it was just a matter of time before the SBP would relent under this twin pressure. Foreign exchange flows have persisted at a pace for nearly a year and SBP has been purchasing dollars and injecting the Pakistan rupee into the system.
Since credit expansion to the private sector has been less than one-third of the credit plan projections, banks' investment in government paper has been around 42 percent instead of the 15 percent required under statutory liquidity condition. Around Rs 240 billion in excess liquidity, in the last 10 months alone, has reportedly gone into government paper.
SBP has been aggressively purchasing dollars not only on spot but also in the forward market and exporters have reportedly sold 10 months forward inflows to the banks in order to hedge against the weak dollar.
The SBP move would result in the lowering of profit rates given by banks to the depositors for July to December 2002. The cut in lending rates will come after a much longer time lag and higher up-take in credit is not likely to be witnessed in the next few months, experts said.
