Gentlemen prefer bonds

Rate cuts are indeed part of government’s political agenda — lower debt service expenses, free up money for subsidies.

Something’s afoot. This last interest rate cut is too decisive a step to have been taken for purely economic reasons. It’s not that the economics don’t justify some relaxation of the monetary noose which the economy has been hanging from since 2008. It’s just that the stars look a little too perfectly aligned here, for it to be an economic decision.

Consider this, for instance. In May, the Monetary Policy Committee was disbanded after a watered down version of the State Bank of Pakistan (Amendment) Bill is passed into law, which does away the most important portions of the legislation: those that pertain to the central bank’s autonomy. Decision-making power is concentrated in the central board of the State Bank, whose members are all appointed and renewed by the government.

Then former governor of State Bank, Shahid Kardar resigns suddenly, amidst swirling controversy. As a first step, the acting governor Mr Yaseen Anwar and the empowered board, start lowering interest rates starting with a small step of half a percentage point. The markets are confused, they weren’t really expecting this. What is going on, they ask. If the government is trying to kick start growth then, half a percentage point doesn’t do the trick.

Then in August, they adjust the way in which the Consumer Price Index (CPI), the main measure of inflation, is calculated. Whether or not this exercise has anything to do with the steady downward trajectory of inflation is something not yet known, but inflation shows a consistent downward trend from July onwards, averaging somewhere around 11.5 percent of the first three months of the current fiscal year.

Yields on government bonds begin to fall, and even more importantly, the market develops an appetite for longer tenors. Did the markets know something the rest of us didn’t? Did they figure out that interest rates will be on a downward trajectory all year into the rumoured single digit terrain, by June 2012? Because if those rumours turned out to be true, it would make sense to move into longer tenors now and lock in the double digit yields while they’re still on offer.

Then in October comes the big rate cut and talk swirls that the step is driven by a political calendar. But how does a reduction in the discount rate make for good politics? Will it really spur growth? The cost of borrowing is not really the main hurdle to investment.

The two percentage point reduction in the discount rate, thus far in the fiscal year has knocked off more than Rs100 billion from the government’s debt service bill, although the benefit of this reduction will come with a lag. For banks, the prospects of a continued steep reduction in the discount rate must be a difficult thought to live with, accustomed as they are to the easy money that sovereign lending brings with it. If those returns are going to dwindle, our poor bankers might actually have to get up and do some work, and actually earn some of those insane packages they make instead of simply raking it in.

It would be interesting to see how much of the Rs800 billion paid by the government as debt servicing last fiscal year went to the banks. It would be even more interesting to break down how much of that was shared by the big five banks. Then we could see how much those banks paid out as dividends to their shareholders, how much was consumed as ‘executive compensation,’ and how much was shared with their so-called ‘Corporate Social Responsibility’ (CSR) budgets. These numbers will show a clear picture of their priorities!

The rate cuts are indeed part of the government’s political agenda — to cut down its debt service expenditure and free up some money for subsidies, as well as procuring for itself the backing of highly leveraged industrial groups that are groaning under the weight of their debt obligations. The big losers in the gambit appear to be the banks, whose preference for government bonds is now being tested. Let’s kick back and watch a rather ungentlemanly stampede into longer tenor government paper get underway.

Published in The Express Tribune, October 13^th, 2011.