Interest rate under pressure

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Pressure continues to mount on interest rates as markets remain stubbornly wedded to their expectation of a rate hike in the near future. The latest auction of government debt instruments (known as Treasury bills, or T-bills) brought a glimmer of good news as banks broadened their participation beyond the shortest three-month tenors, where they had huddled for a number of months, but the yields being demanded continued to rise.
As a result, the government fell short of raising its target of Rs850 billion by Rs113bn. This is not alarming but noteworthy nonetheless, especially since the auctions since November at least have been seeing large participation in three-month papers that are now maturing and need to be rolled over. The banks are demanding higher yields for rolling these over since their outlook shows inflation to be higher in the closing months of the fiscal year and the State Bank has committed itself to “mildly positive real interest rates” in the last monetary policy statement from January.
Three-month papers saw Rs252.4bn offered via 105 bids in yesterday’s auction, of which 92 bids were accepted for a total of Rs237.7bn. The rest fell above the cut-off yield. The largest participation was in six-month papers that raised almost Rs500bn from 85 bids out of a total of 119. Bids for 12-month papers were rejected again, in a repeat of what happened in the auction back in January.
Here are the numbers that matter. Yields on three-month paper rose by almost seven basis points in two weeks and six-month yields rose by 6bps. Again, this is not alarming, but shows that the financial markets continue to see the current discount rate as too low. What is more illustrative is to note how far yields (weighted average) have travelled since June last year, when the last of the Covid rate cuts was applied bringing the policy rate down to seven per cent. Since then, yields on three- and six-month papers have risen by 34bps and 83bps respectively. The yield curve on 12-month paper has been shattered currently, since the yields being demanded by the banks are 130bps above what they were in auction on June 30, the first since the policy rate bottomed out.
The good news is that the market is now willing to go as far as six months on government paper, which was not the case as far back as January, when most bids were cast only in three-month paper. The bad news is that their expectation of a rate hike has not been tempered.
The market has its reasons for expecting a rate hike. For one, the State Bank has committed itself to bringing back positive real interest rates in the near term, and with an IMF programme on the radar, this commitment is more likely to be cemented rather than weakened. And on the inflation front, they are looking at the index of the Consumer Price Index from last year and seeing a large bump simply from the base effect. Compounding this will be the effect of rising fuel prices as well as rising power tariffs.
Some among them are also pointing to looming external sector vulnerabilities as the current account once again swings into deficit for the months of December and January, a trend that is unlikely to reverse if the growth momentum keeps up, since it was the collapse in the growth rate that largely accounted for the declines in the trade deficit, the principal driver of the current account. The trade deficit for the months of December and January has remained above $2bn going by State Bank figures.
Add to this the looming pressures that are about to kick in once the moratorium on debt-service payments expires in the month of June. According to a World Bank estimate, Pakistan had close to $3.6bn worth of external debt service payments come under the moratorium that was announced by the G20 in the early days of the Covid lockdowns. That money was not written off. The payment schedule was simply pushed forward by a few months, and repayments are scheduled to commence from June, likely placing more pressure on the external account.
From all sides now — the financial markets, the multilateral lenders, the pressures growing within the economy — the government is set to face growing headwinds in the closing months of this fiscal year till June. The budget that is to be drawn up as these headwinds are gathering momentum will have to consider stabilisation once again, meaning a renewed focus on taxes and debt sustainability, which in Pakistan’s case often means devaluation.
This is a good time to free oneself from the rhetoric and start regarding reality with a dispassionate eye. The inclination among some to celebrate the movement of individual indicators will be tested, as will the inclination of others to bury the reality in a mountain of detail and try to keep the smile on one’s face.
The fact is the economy has been riding on a small spurt of inducements that are going to become increasingly difficult to maintain, let alone carry forward into the next fiscal year. Corporate earnings have risen sharply in the period since the Covid lockdowns were lifted, rising by an average of almost 70pc in the second quarter, and far more sharply in the case of some industries. Individual incomes have not grown at the same pace, and it is a good bet that neither has unemployment dropped at the same clip.
The months since the lockdowns were lifted have seen the government reap an unusual bonanza. It was freed, momentarily, from the shackles of the IMF, spurred by a $1.4bn injection from the Fund that was used to support government finances, while the virus failed to wreak the kind of deadly havoc it has wrought on Western countries. That honeymoon may be drawing to a close.