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Why Bond Auction is Scraped ?

May 18, 2016

Today State Bank of Pakistan announced scraping of Pakistan Investment Bond’s auction, which is second time in 3-weeks. Earlier on April 27, SBP rejected T/bills auction. SBP does not give reason for rejection.

Tough demand in both, T/bills and PIB auction has been strong, but the message is very clear that SBP/MOF is not comfortable giving higher cutoff that does not reflect Central Banks accommodative stance.

It makes little or no sense that banks have been demanding better return than the 6-month average KIBOR rate, which is around 6.27 pct that could be one of the causes of scraping of T/bills at an earlier date. In its last T/bills auction SBP accepted all bids that was closer to KIBOR rate.

After giving clear signal to the market in its last PIB auction, policy makers must be excepting similar bid pattern trend in today’s PIB auction.

But prior to Bond auction few banks made desperate effort to jack up yields sharply by offering sale of T/bills and Bonds at higher yields in small amount hoping that market will bid Govt Paper at higher yield. It was bad idea that has backfired.

With Open Market Operation (OMO) injection amount of Rs 1.32 Trillion costing 6.05 pct, investment at current levels are not attractive for investors due to nominal return. Financial Institution’s desperate bidding pattern is understandable as they are holding large size investment portfolio, hence the appetite for government paper must be very low, as interest rate risk is another matter of big concern.

Market is basically betting on expectation that government is left with no other choice and will be forced to offer lucrative return on investments to contain its fiscal deficit target. They are also of view that SBP has no other alternate option to reduce OMO injection, which has been hovering around Rs 1.4 trillion for quite some time and will succumb to pressure.

However, market should be aware that oil savings of nearly USD 14 Billion in last 18-20 months means reduction in liquidity requirement since then that has gradually reduced by nearly Rs 1.45 Trillion due to lower oil bill and more importantly it is not only banks that are holding government paper. Total Non-Bank Holdings of GOP Securities is Rs 1.535 Trillion. Not all, but sizable amount of their holding is also maturing in short term, which means, corporate demand could suddenly pop up.

Therefore it’s a win-win situation for SBP/MOF and for the first time they can afford the luxury of refusing to accept market demand for higher yield.

Finance Minister Isaq Dar on numerous occasions has spoken of higher cost of debt. Soon after his return from Dubai after meeting with IMF, FM in his press talk has clearly said that he is expecting inflation to close around 3 pct by Fiscal Year end. I have several times pointed out in my write-ups that I am expecting inflation to close around 3.10 pct by end of June and I stick to my target.

There is a clear hint that the government is extremely concerned with the pace of rising debt, which is not manageable until there is substantial rise in Revenue Collection and surge in Exports and with slow down of growth pace of remittances, all three are indicative of the fact that the pressure on debt will continue to mount, which will keep on surging unless checked immediately.

Whereas, market cannot dictate its terms to SBP, as still have quite a few monetary tools in its sleeves. SBP can widen the corridor gap or even remove corridor at a later stage, it can slash target rate or leave inter-bank market liquid.

I am quite confident that the government will not go for another IMF deal after receiving its September tranche. While talking to press FM Dar has shown aggression projecting 6 pct to 7 pct growth in next couple of years. Govt says it will add another 10.000 MW electricity by end of 2017. With such ambitious target government has to tame down and reduce cost of doing business higher so that businesses can become competitive.

Therefore, in all probability, rate hike is not expected any time soon, not even in 1st quarter of FY 16-17.

In fact rate cut is still a favorable option that will help to reduce cost of debt financing and simultaneously will help to reduce cost of doing business to stimulate economy.

Hence, in all probability, T/bills and Bonds yields will gradually ease, as corporate demand will add buying pressure.


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