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State Bank allows market to increase PIB yields

KARACHI (May 29 2004): The State Bank of Pakistan has finally relented and allowed the market forces to determine the cost of government borrowing by adhering to the target and letting the yield rise by 66, 47 and 88 basis points on three, five and ten-year Pakistan Investment Bonds, respectively, on Friday.

Threats to quash the auction in case the 10-year bond yield crossed the seven percent mark did not materialise.

Economists at the central bank appeared to have prevailed over the treasury experts in the auction committee, at SBP, to let the target size dictate the rates instead of punishing the banks for not bidding within a specified range.

According to experts, the implications of Friday's decision were:

(a) The 15- and 20-year PIB bonds in the forthcoming auction are likely to be sold at a discount;

(b) Banks would face difficulty in reselling the PIBs to clients who have already bought PIBs at 6.50 percent or on 'when-issued-basis' ie 6.70 / 6.75 percent;

(c) Fund managers at non-bank institutions would continue to sit on the sidelines until they are convinced that the rising interest rate scenario has ended and there is stability in rates; and

(d) A number of banks, especially in the private sector, would be severely hit as they book losses on their existing PIB holdings, doing valuation on 'mark to market basis'.

The Pakistan Investment Bond (PIBs) yield surged as the State Bank accepted the targeted face value amount of Rs 14.857 billion in its Second Jumbo auction for 3, 5 and 10-year by raising yield by 66, 47 and 88 basis points, respectively. The 3-year yield rose to 4.305 percent from 3.77 percent; 5-year saw yield rising to 5.3492 percent from 4.9007 percent; and 10-year was accepted at 7.3698 percent yield against last cut-off yield of 6.4903 percent.

Friday's dip in bond prices offset gains made during the earlier part of the week when Treasury managers were warned by the SBP surprised money market by rising 6-month T-bill yield by 34 basis points on the eve of PIB Jumbo bond auction, which was enough to motivate investors to sell bonds, as it thought this was a clear signal that the short term interest rates were on the rise.

A larger number of market players now believe that yield for one-year Treasury bill rate would be raised to between 4 percent and 5 percent by the year-end.

A number of the bond traders have started talking of hike in discount rate and say that they would not be surprised to see the rise in discount rate before the year-end.

On November 18, 2002, discount rate was slashed to 7 1/2 percent from 9 percent. They reminded that during that period cut-off yield for 10-year bond, which was 9.32 percent on October 24, 2002, was also clobbered down by 376 basis points to 5.56 percent yield in the next PIB auction held on December 31, 2002.

A treasury head of a foreign bank said, “Soon after the announcement, corporate customers rushed in with their query, asking for bond prices. I have sold half a billion in 10-year to one customer who probably waited for the market to settle down after the auction. I have also sold to customers with smaller lots. This is very encouraging. The current pace suggests that 15- and 20-year bond auction will definitely attract customers in the coming auction”.

Soon after the announcement, the market sold 10-year at 7.50 percent yield, but demand from investors pulled it down to 7.25 percent yield. At the close, the market was bidding 10-year at a yield of 7.30 percent, 5-year at 5.35 percent yield, while there was no demand seen in 3-year.

“I think it's a bold decision taken by the SBP. This will certainly bring stability in the bond market. Market sentiment cannot be changed forcibly; it is the demand and supply factor which determines the price,” said an active money market dealer of a local bank.

Major money market dealers believe that the confusion about the rates should not exist anymore, which should see demand arising from the corporate sector and 10-year bond yield should settle between 7.25 percent to 7.5 percent.

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