The interest rates could be easily gauged from the central bank's move through selling treasury bills

July 25 - 31, 2005

Interest rates signal different shades of the country's economy and how the central bank and experts at the helm of Ministry of Finance are catering to the demand of the private sector, curbing inflation, controlling liquidity in the market through the tightening monetary policy.

The national economy has witnessed a sea change during the past couple of years through stringent measures taken by the central bank after aid flow from the overseas donor agencies, growth in exports and phenomenal increase in remittances improved the liquidity, increasing the flow of rupee in the money market, help trimming the interest rates, resulting in growth in lending from the domestic industries. During the past two fiscal years, the credit growth in the country was tremendous and over 600 billion rupees were witnessed as credit-off take, most of which went to textile sector for expansion, meeting the demands of ever-rising growth at the international markets and fulfilling the condition of WTO. Agricultural sector was also one of the major candidates of the bank borrowers, as it bolstered the agricultural growth in the country, leading to expansion in the $95 billion economy, aiming to touch 8.4 percent, fastest in 20 years in the year ended June 30, 2004.

The interest rates could be easily gauged from the central bank's move through selling treasury bills. The rates on these government securities have more than doubled since the start of 2004 because of the monetary expansion and central bank stance to suck liquidity from the market, aimed to curb inflation. The rates on three-month, six-month and one-year treasury bills currently stood around 7.69 percent, 7.98 percent and 8.69 percent, respectively.

Though it is increasing the financial cost of the companies but analysts were of the view that because of expansion in the local industry and growth in economy, the sales of the companies are on the rise, mitigating the financial burden. Interest rates started rising following big buying from the State Bank of Pakistan in all of its auctions held in last six months, which caused sharp increases in treasury bills rates. However, the rising inflation owing to increase in food prices and crude oil rates in international market, the bank was forced to increase the discount rate by 150 basis points to 9.00 percent. In November 2002, the bank cut the discount rate by 150 basis points to 7.5 percent, lowest in the history of the country to bail out the economy's long bearish spell.

The discount rate is an interest rate that an eligible depository institution charges to borrow short-term funds directly from a central bank. Since last few years this benchmark rate is losing its importance because the rate was not moved frequently in line with T-Bill, PIB and lending rates. In fact bankers and other people started ignoring the discount rate while pricing their products. And after the introduction of KIBOR in late 2001, most of the benchmarking is now linked with KIBOR. However, despite all this, discount rate is considered as a strong signal from SBP about the future direction of interest rates. After the recent 150bps increase in discount rate on April 11, 2005, the central bank has showed that it is becoming aggressive, a leading treasurer said.

According to a bank official, the rates have started climbing from December 2004 because of higher demand and glut of booking orders from the consumers wanting to purchase home appliances, vehicles and loans for construction and buying homes. The rates at present ranged from 13 to 15 percent depending upon the product, increasing from 7.5 percent. "Now there is a lust for acquiring loans or rather one can say an addiction, to get a new car, a consumer has to pay only 10 percent, which is quite a charming deal," he explained.

Following the increase in rates, at present the monthly installment has been increased only by Rs 500 to Rs 750 which is still bearable and we haven't saw any drop in bookings, rather consumers are paying premium to get vehicles such as Toyota, Suzuki, Santro and Honda." The Ministry of Finance and State Bank of Pakistan would not allow the interest rates to accelerate on two counts - they want economy to expand and achieve growth target of 7 percent for the current year and don't want to cap the industrial and investment progress to achieve revenue targets, opportunities of new jobs and cut poverty, he said.

Commercial banks have revised the rates upward by 100-200bps on consumer financing products following the change in the discount rate by State Bank of Pakistan as on April 12, 2005. "We do not see any major impact on the business of car financing and growth of auto sales likely to continue. After the change in discount rate in April car sales number remained impressive in May and July, said Muhammad Imran, Research Analyst at Jahangir Siddiqui Capital Markets Ltd. In July 13668 cars were sold which was the highest number of cars sold in any single month. "A rise of 100-200bps is not significant to curtail the demand of autos and we are expecting that the demand of autos will grow in coming years, which ultimately benefits the auto finance business."

The SBP and Ministry of Finance were quite active for the last couple of years and strictly monitoring the interest rates movement, loans owed by consumers and measures taken to allow credit expansion. SBP has set a target of 13.05 percent monetary expansion for FY06. This target is set on the basis of an estimated 7 percent GDP growth rate and 8 percent inflation.

Noman Yousuf, Research Analyst at Aqeel Karim Dedhi Ltd., said that monetary expansion target is set below nominal GDP growth (adding GDP and inflation means 15 percent) due to the occurrence of substantial monetary hangover (a situation when expansion in a year is more than growth in that year). "However, our estimate is that monetary expansion is likely to be slightly below target, due to our assumption of lower than target demand in private credit disbursement." Unlike late 90s, when government borrowing constituted a substantial portion of monetary expansion, now the major force behind monetary expansion is demand for credit in the private sector.

SBP has set the target of 21 percent growth this year, but the private sector borrowing might increase by 18.4 percent. This relatively slower momentum is expected due to large base effect and the fact that the demand for consumer loans is expected to slow down a bit given the higher interest rates. But the private credit augurs well for the banking sector because the demand would still be in the double-digit zone, boosting their earnings. Some impact would translate into the bank earnings because of the recent hike in NSS rates, but as the financial institutions foresee these happenings, several schemes have already been launched offering 9 to 10.5 percent on their deposits with planners ranging from three to five years.

Khalid Iqbal Siddiqui, head of research at Investcapital Securities believed that a relatively modest increase in NSS rates reflects government's three key considerations. First, as high oil prices are already putting pressure on government's fiscal resources, the government is trying to keep its fiscal costs in check. Second, with the government fighting hard to contain inflation it does want to reinforce expectations of high inflation over the longer term, which in turn would feed back into higher PIB yields. Third, the government would like to pre-empt repeat of 2002-03 situation when higher NSS rates versus lending rates created arbitrage opportunities in NSS investments, resulting in sharp rise in NSS inflows.

Interest rate outlook the inflation CPI for the year FY05 was recorded at 9.28 percent. Although it is on higher side yet a positive point is that after double-digit inflation of 10.25 percent and 11.1 percent in March and April, respectively, inflation started to cool down in later month of FY05. CPI for June was recorded at 8.74 percent. For the next year analysts are expecting the CPI will ranged between 8-9 percent. Interest rates are also likely to be stabilized in near future. The tightening monetary policy stance of State Bank has started to show its result therefore analysts do not see any significant upsurge in interest rates. The trend is witnessed from last 3 auctions where the benchmark 6 month T-bill has stabilized at 7.98 percent. However, any increase in discount rate from 9 percent to 10 or 10.5 percent, according to the rumors circulating in the market, would be dampener for the stock market and also for some of the banks, which have made hefty investment in Pakistan Investment Bonds. Increase in discount rate would force the banks to liquidate their equity holding in the domestic stock market, resulting in huge losses.

Moreover, it would increase the yields on Pakistan Investment Bonds, i.e. reducing the bond value, hurting their earnings as their portfolio carry huge holdings of long-term bonds. The State Bank of Pakistan in its last monetary policy for the six months said the country sought to maintain a balance between achieving growth targets and reining in inflation by raising interest rates. ``Fighting inflation would remain the primary objective of the monetary policy but higher economic growth, productive employment and capacity expansion would neither be abandoned nor stifled.''