ISLAMABAD: Although elevated money market rates helped stabilise exchange rate by increasing the cost of rupee liquidity yet it not only discouraged speculative activity in the FX market, but also kept the interest rate differential between the rupee and foreign currency loans high.
A highly-placed source at the Finance Ministry told this scribe here on Wednesday that 15 commercial banks, including three major banks, used reverse repo facility of the State Bank of Pakistan at least 4 times to secure liquidity during the third quarter of the current fiscal year which indicated money market rates remained elevated during the quarter.
Moreover, the source said that demand for FX loans to finance oil payments also factored at that time when FX reserves were falling of the SBP, specifically, trade financing against FE-25 deposits increased by $ 940 million against a net retirement of $ 431 million during the same period in FY13.
The source added that appreciation of the rupee against dollar also contributed to this increase, as the effective cost of foreign currency borrowing depended on expected depreciation and appreciation of rupee and the interest rate differential between domestic and international markets. “With a large interest rate differential and an appreciating rupee foreign currency loans became very attractive,” the source said.
The source said that money market liquidity remained at considerable volatility due to pickup in private sector credit, sharp reduction in government borrowing, the unplanned substitution of short-term debt (T-bills) with the medium to long term instruments (PIBs), the unexpected external inflows, unanticipated exchange rate developments and the market view about interest rate. “Not only did the money market rate move outside the normal interest rate corridor (IRC) at times, the OMO cut-off rate were also higher than the SBP’s reverse repo rate, which is the upper limit of the IRC,” the source observed.
The source said that excess liquidity prevailed in the market prior to the November 2013 decision as the weighted average overnight rate was hovering near the middle of the IRC; and SBP was conducting open market operations (OMOs) to drain liquidity from the market and individual banks were frequently placing their funds with SBP at the floor rate.
“But as government accepted huge amounts in auction of T-bills and others, to retire its borrowing from SBP to meet end-December targets, it pushed the cut-off rates for all tenors almost to the policy rate, creating a very flat yield curve up to one year maturity,” the source added, saying that the overnight money market rate also exceeded the policy rate (reverse repo rate) on various occasions, as SBP provided limited liquidity through OMOs in a market where commercial banks had overcommitted in the primary auctions.
