Monetary Policy #13: 63 day RRP back in fashion
3M T-bill cutoff in the next auction expected to drop by another 16-26bps
We talked about 63-day RRPs a lot in this space, with the conclusion that
Monetary Policy #4: SBP is encouraging carry trades (substack.com)
This is SBP encouraging carry trade in T-bills.
This is an open secret in the money markets of Pakistan: Borrow short term on RRPs at 9.9% and lend to GoP for 3 months 10.4%. [allowing the banks to earn a risk free spread of 40-50bps on 3-month T-bills]
While Reza Baqir did have a few wins such as TERF, RAAST, etc. as I covered in my piece DMKM on Reza Baqir's three years at SBP, it is also a fact that SBP’s monetary policy committee lost all credibility during his stint, as Uzair noted in his Profit piece.
The SBP’s rising credibility issue - Profit by Pakistan Today
The State Bank of Pakistan has a growing credibility problem. For the past several months, Pakistan’s central bank has been chasing an elusive inflation target.
…..Below are some quotes from the SBP’s Monetary Policy Statements with regards to its medium-term inflation outlook:
January 2020: “The MPC also viewed the current monetary policy stance as appropriate to bring inflation down to the medium-term target range of 5 – 7 percent over the next six to eight quarters.”
January 2021: “As a result, inflation is still expected to fall within the previously announced range of 7-9 percent for FY21 and trend toward the 5-7 percent target range over the medium-term.”
July 2021: “As a result, inflation is still expected to fall within the previously announced range of 7-9 percent for FY21 and trend toward the 5-7 percent target range over the medium-term.”
January 2022: “However, during FY23, inflation is expected to decline toward the medium-term target range of 5-7 percent more quickly than previously forecasted as demand-side pressures wane faster due to the Finance (Supplementary) Act.”
The January 22 statement (in bold above) shows that Reza Baqir’s SBP had lost all touch with reality.
A few days after Reza Baqir left, SBP finally raised the policy rate in April. Mustafa Pasha wrote this damning piece (emphasis in bold, mine).
SBP succumbs to reality (tribune.com.pk)
The State Bank of Pakistan (SBP) has finally taken a much overdue and corrective decision by increasing the policy rate, by a massive 250 bps to 12.25%. To put this move into context, such a large jump has not been witnessed in the 21st century.
Interestingly, the SBP has not given any forward guidance as it believes such a strong and decisive action speaks for itself. It also claims that future real interest rates are now in mildly positive territory while external financing needs for FY22 are fully met.
Unfortunately, this decision also highlights how behind the curve the SBP was in terms of monetary policy and the flawed logic of holding rates steady in January and March stands cruelly exposed. The market has once again won and forced the SBP to fall in line. This is evident from the unprecedented spread that existed between the policy rate (9.75%) and treasury bill/ KIBOR rates (~13.0%). This move was essentially filling in the gap the market had already created and was not as proactive as some tweets would have you believe.
Despite the first line of the second paragraph stating that SBP felt that forward guidance was not needed as the unprecedented move of increasing the rate by 250bps spoke for itself, SBP again raised the policy rate by another 150bps on May 23, 2022. It is as if the market could not trust SBP again.
The May monetary policy statement had a few interesting tidbits:
Thereafter, it is expected to fall to the 5-7 percent target range by the end of FY24, driven by fiscal consolidation, moderating growth, normalization of global commodity prices, and beneficial base effects.
The “moderating growth” is interesting. It implies that SBP wants and expects the growth to be brought down if the inflation is to fall, i.e., the economy is overheating. This is further substantiated by the following sentence, where SBP states that the “economy will benefit from cooling.” We don’t know how SBP calculated the positive output gap, but that also implies an overheating economy.
With the output gap now positive, the economy would benefit from some cooling. On the back of monetary tightening and assumed fiscal consolidation, growth is expected to moderate to 3.5-4.5 percent in FY23.
For that to happen, SBP wants a sustainable growth rate of 3.5-4.5%.
A T-bill auction with a target amount of Rs.750 billion is due on June 1, 2022.
The inflation is elevated. There is no forward guidance from SBP anymore. The cutoff yield on T-bill auctions keeps increasing with every auction. SBP has yet to establish credibility that was lost in the final months of Reza Baqir’s tenure. All that is left is to do a 63-day RRP, which in the words of Ariba Shahid, Reza Baqir’s most prolific interviewer (other than Bloomberg), means
“please take our money and lend it back to us, but hey, hold back on the yields, will you?”
This is what SBP did on May 27, 2022
Or if you want the boring explanation from the same piece
“Forward guidance is just guidance, and this (OMO injection), on the other hand, is a concrete step,” says Rauf.
“This would signal to the market that SBP is willing to accept a fixed return for 2 months, which means policy rates would remain unchanged in the near term,” says Rauf.
Banks don’t care about the policy rate anymore, as SBP has been behind the curve. However, banks do care about profits, and the 63-day RRP allows the banks to make a nice little spread.
What SBP is doing here with the 63-day RRP, is lending money to banks for two months at 13.84% in the hope that, if the recent past is any guide, in the next T-bill auction, the banks will lend to GoP at a spread of 40-50bps over the RRP rate i.e., 3M T-bill cutoff at 14.24%-14.34%. The previous 3M cutoff was 14.5% (See below). Thus, SBP is trying to bring down the cutoff by another 16-26bps. Moreover, while the target for the auction is Rs.750 billion, it is expected that banks will lift a higher amount as the RRP was for Rs.1.8 trillion.