EDITORIAL (November 05 2008): Despite slashing of cash and liquidity ratios, as well as greater emphasis on sectoral financing to key areas of the economy, the private sector is complaining of a credit squeeze and risk, besides cost of borrowing. About a fortnight back, the Governor of State Bank of Pakistan (SBP), had announced certain measures in an extraordinary press conference to boost the liquidity of banking system by about Rs 240 billion.
Cash Reserve Requirement (CRR) for deposits up to one year maturity was slashed by 200 basis points to 6.00 percent and time deposits of one year and above were exempted from Statutory Liquidity Requirement (SLR). These two measures were expected to release an aggregate liquidity of Rs 180 billion immediately into the system and contribute significantly in alleviating the liquidity strain in the market.
The central bank also directed the banks to maintain "advance to deposit ratio (ADR)" equal to or less than 70 percent, but in order to ensure a smooth transition of banks' balance sheets, March 31, 2009 was prescribed as the cut-off date to meet this requirement.
Almost a week earlier, ie on 11th October, 2008, the State Bank had injected Rs 30 billion in the banking system through a reduction of 100 bps in CRR. It was also announced in the press conference that CRR would be lowered further by 100 bps to five percent on 15th November, which would add another Rs 30 billion to the liquidity of banking system.
According to the SBP Governor, all of these measures were temporary and aimed at accommodating extraordinary requirement of the banking system and, therefore, should not be construed as a change in the monetary policy stance. All of a sudden, the State Bank has now moved to cut the banks' CRR by one percent to five percent on 1st November, or a fortnight before it was due on 15th November.
The State Bank, as is well known, has been following a tight monetary policy since 2005 in view of excessive liquidity expansion and the resulting inflationary impulses in the economy. It was generally believed that the central bank would ease its monetary policy once the goal of price stability was achieved.
As the latest developments show, the price level, instead of stabilising, has witnessed a sharply rising trend, indicating the need of tightening the monetary stance further. However, the State Bank seems to have changed the course due to abnormal developments in the financial markets of developed countries, liquidity squeeze in the local banking system and apprehensions of depositors about the safety of their deposit accounts which could have led to a run on the banks.
Some analysts were of the view that the State Bank's apprehensions were mostly misplaced since the factors which had caused global meltdown were not very relevant to the situation in Pakistan, but it could also be argued that the injection of a huge amount of liquidity was precautionary and meant to neutralise the fall-out from adverse developments, both at home and abroad.
Although it is difficult to pronounce some sort of final judgement yet the State Bank seems to have acted in good faith and on solid grounds. Persistence of unusually high rates in the interbank money market and the requirement to finance commodity operations in the coming busy season seem to have played a vital role in the State Bank's decision to boost liquidity in the banking system.
However, what is not understandable is the unusual reaction of the State Bank to the developments which could have been dealt with in a routine fashion. For instance, eyebrows were raised when the Governor called an extraordinary press conference late in the evening of 17th October to announce measures herself which could have been communicated to the banks through a circular.
People were expecting that night some draconian measures in the foreign exchange market to stem dollarisation of the economy and outflow of foreign exchange, but were dismayed to hear monetary terminology which was generally beyond their comprehension.
Liquidity had dried up in big network banks, primarily due to heavy borrowing by the public sector entities. And, small and mid-tier banks had been adversely placed due to the fall in the equity market.
The release of Rs 240 billion liquidity has allowed the banks to top up their tanks. However, despite being comfortably placed, banks are hesitant to expand their credit portfolio. This hesitancy is primarily due to the fear factor. Even on committed loans, banks are demanding a higher rate after pricing in the upsurge in risks in a global slowdown.
Banks are not sure about the monetary and fiscal position after Pakistan has signed up with the International Monetary Fund. Further, the present crowding out of private sector credit will persist until the IPPs' existing advance to various oil sector and utility companies is retired. That can only happen once aid and loans from multilateral agencies (excluding IMF) and Friends of Pakistan materialise.
Only then the lending pool will expand. This may take a few more weeks or a little longer. As a bridge finance, SBP could reduce the SLR from 18 to the normal 15 percent level in order to prime the credit flow in the peak lending season. SBP had formed a committee of bankers to fine tune the KIBOR formula. It appears that the focus on reducing bank spreads has shifted as the banking system is being increasingly relied upon to rescue the players in the capital market.
