Weaknesses spotted in State Bank's foreign exchange regime monitoring mechanism

KARACHI (January 27 2003) : Banks have ignored the State Bank Governor's press statement that a cut in the discount rate is not on the anvil and have conducted deals for one year government paper on the interbank market at an all time low of 2.65 percent.

Trades for six months treasury bills were reportedly also undertaken at 2.25 percent by the end of last week.

The prime rate acts as a benchmark for interest rates abroad. In Pakistan, the discount rate of SBP is regarded as a barometer for lending rates.

Long-term deals are mostly concluded by banks with their clients with linkage to either the T-bill rates or the SBP discount rate.

SBP reduced the discount rate to seven percent late last year. Now with one year treasury bills trading at 2.65 percent, the gap has grown by more than four percent, thereby putting pressure on the central bank to cut the discount rate further.

Treasury managers also feel that SBP has become sensitive about the cost of regulating the monetary policy in its Profit & Loss Account.

The cost of forex reserves building and aggressive purchase of dollars from the interbank market to keep the rupee overvalued against the dollar and the continuous shift by customers from dollar deposits to rupees is entailing a heavy cost.

It is said that a strengthening of the rupee against the dollar by 100 basis points now translates into a Rs 9 billion loss on SBP's P&L account.

Since the central bank's policy of keeping the rupee undervalued has borne results, with exports rising by 16.5 percent, in the first half of fiscal year.

The policy of giving a subsidy through the exchange rate for exports is for more prudent than giving industry specific subsidies which distort the system.

Therefore, the treasury managers feel that SBP would opt to let the yields on government paper come down and also remove the gap between the dollar interest rates and the mark-up on the Pak rupee and avoid a substantial shift in the rupee-dollar parity.

At present, SBP gives the dollars to banks under its Export Refinance Scheme at 4 percent and banks are told not to charge more than 1.5 percent extra from clients.

The banks, depending on the volume of business, are said to be charging around 0.75 percent to 1.25 percent, so it costs the exporter between 4.75 percent and 5.25 percent on borrowing in dollars under the SBP export refinance scheme.

The treasury managers say that the choice for SBP is either to disallow further dollar refinance facility, which has already crossed the one billion mark and is on a continuous upsurge, or else raise the cap of 1.5 percent placed on banks of with a floor of three to 3.5 percent to raise the cost of dollar financing to 7.5 percent and bridge the gap with Pak rupee financing to the export sector.

It is said that in the past the Pakistani central bank was buying dollars on the forward market to build its forex reserves. But with exporters aggressively selling their future dollar receivables to banks and importers being shy of booking their future import needs, banks are left with no choice but to sell their dollars to SBP.

For the last ten days SBP has been selling dollars on the forward market, giving comfort to the banks in maintaining NOSTRO limits and not wanting to go short on the dollars, say the treasury managers.

Knowledgeable sources are of the opinion while the SBP has made all the right moves in liberalising the forex regime by relaxing the exposure, NOSTRO and trading limits on banks, as well as allowing forex commercial loans to clients, the monitoring and execution mechanism of the forex regime by SBP needs further strengthening as some banks are making good money at the SBP's cost due to this weakness.

It is also felt that SBP has been slow in increasing the yields on its dollar deployment as well as in coming up with schemes and regulations which can guide banks to utilise their rupee portfolio and generate income from the bloating deposits.

To date, the cut in yields on government paper has resulted in banks proportionately reducing the profit paid to the depositors, with only a marginal reduction in the cost of intermediation.

“This would be reflected in healthy profits earned by banks, despite a massive reduction in their investment in government paper, in the balance sheets for 2002”, experts added.

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