SBP has consistently injected Rs 250 billion every quarter to keep the wheels of the economy churning, allowing the government an incremental increases in its borrowing from the banking system every fortnight.

While the government has endeavoured to keep its budgetary borrowing from SBP, within the June 30, 2011 figure of Rs 1.5 trillion - it has, in essence, borrowed money from banks injected by SBP, through its open market operations. The likely end-result is to put pressure on the price line in the country.

However, there is one difference. When government borrows from SBP, the money supply rises. When government borrows from banks or non-banks, money supply does not rise.

But in the present case, SBP's continuous injection of liquidity at the rate of Rs 30 billion a day has the same effect. Borrowing from SBP is regarded as a zero-sum game as profits of SBP flow back into the budget. Borrowing from banks, by the government, results in transfer of money as interest payments from taxpayers into profit for bank shareholders.

POLICY RATE CUT: SBP's policy rate cut of 150bps has failed to jumpstart the economy. The situation warrants a regulatory intervention to ensure flows to productive sectors of the economy. At present, there is no liquidity in the system despite SBP's persistence injection as all of it is mopped up by the government or provided to the enterprises under its control.

Banks have been converted into asset management companies, with investment portfolio of 40 to 45 percent. The Advance-to-Deposit Ratios (ADR) has fallen from a high of 70-75 to 60-65 percent. SBP did impose a ceiling on ADR of banks, however, there is no floor on ADR.

This in effect fails to put pressure on banks to extend lending to the private sector, which is known as the engine of growth. "Now there is very little difference between banks and non-bank financial institutions. All of them are placing funding in governmental bonds through money market operations," said a leading treasurer, requesting anonymity.

There is total lack of coordination between the debt management wing of the Ministry of Finance and the money market managers in SBP. In the last treasury bill auction, government raised Rs 113 billion in three, six and 12 months paper @ 11.87 percent; 11.91 percent and 11.93 percent, respectively. A day later SBP injected Rs 210 billion through its open market operations at 11.56 percent.

Although, SBP's liquidity injection is for one week tenor, a continuous administration of injections weeks after weeks (Rs 337 billion a week before) indicates a one-side trend. There is no end to government appetite for borrowing. Nor is the government interest rate sensitive.

Unless there is a heavy dose of external inflows or government and SBP jointly take steps to lower the currency-in-circulation amounting to Rs 1.65 trillion, the liquidity in the financial system will remain tight. Seasonal advances will soon follow the four-week hike in cash needed during the Eid holidays.

SBP will have to inject more liquidity sooner than later. This injection is of a permanent nature and ultimately will find its place on SBP's balance sheet. There is no difference in note printing or liquidity injection by SBP via the banking system. In both cases the consequences are the same - rising inflation. The present strategy, therefore, would lead to high inflation. It is bound to adversely impact the exchange rate. Rupee depreciation may exacerbate inflation further.

According to SBP's own survey, corporates, in Pakistan, change their price more than once a year. The most important factor sighted in the survey indicates rupee depreciation.

There appears to be no conceptual change in economic managers' strategy who appear to be more inclined towards fiscal arithmetic. A rate cut in National Saving Centre instruments - soon after SBP's policy rate cut-based on alignment of rates with three, five and ten-year bonds - was a profound error.

Corporates are no more allowed to invest in NSS instruments. National Savings Centres (NSCs) are now more or less retail outlets. Government needs to encourage household and private savings towards NSS - so that an increasing reliance on banks is effectively checked.

SBP needs to restructure its discount window and the government needs to bridge its expenditure-resource gap through non-bank sources, i.e., either multilateral or bilateral aid or loans or borrowing from local non-bank sources. At the same time, fiscal authorities need to help the banks by reducing the tax on cash withdrawals in order to lower the high level currency-in-circulation and push it towards deposit taking. The present disconnect between liquidity management and lending rates needs to be addressed so that money is made available to the private sector to boost growth.

SOURCE: BUSINESS RECORDER