Liquidity problems: Return on bonds rises as govt continues to borrow

Investors purchase Rs25b worth of Pakistan Investment Bonds in auction.

ISLAMABAD:

In what appeared to be a sign of liquidity shortage due to government borrowing, the yield on 10-year investment bonds has risen to 13.11%, an increase of 41 basis points in a month.

The government on Thursday borrowed Rs25 billion through auction of Pakistan Investment Bonds (PIBs), having maturity of three, five and 10 years, said an official of the finance ministry.

The auction results show that investors, mainly banks, purchased 10-year PIBs at 13.11%, which is 41 basis points higher than the last auction held on February 15. Similarly, the yield on five-year PIBs rose to 12.89% from 12.68%, up 21 basis points. Yield on three-year PIBs increased to 12.5%, 10 basis points higher than the last auction.

Analysts say the increase in bond yields not only indicates a shortage of liquidity, but also makes the discount rate – at which the central bank lends to commercial banks – ineffective. Currently, the discount rate stands at 12%.

Analysts say on the one hand the central bank injects money at around 12% through open market operations while on the other hand the government borrows the same from banks at higher interest rates. According to a recent report of the State Bank of Pakistan, profits of large banks rose by 27% last year.

However, both the central bank and finance ministry rejected talk of liquidity shortage.

“Weighted average yields of three, five and ten-year bonds rose by 10 basis points, which is okay in the given inflationary pressure,” said Rana Assad Amin, Special Secretary of the Ministry of Finance.

By March 12, he said, the government had borrowed Rs918 billion for budget financing, including Rs390 billion to clear power sector arrears.

“Had the government not borrowed Rs9 billion by selling 10-year bonds, the borrowing from the central bank would have increased by the same amount,” said Amin.

As foreign financing has almost dried up, heavy government borrowing from domestic sources has virtually left nothing for the private sector, hurting the growth of industry as well as jobs.

SBP chief spokesman Syed Wasimuddin was also of the view that there was no liquidity shortage in the market. Defending the increase in return on long-term bonds, he said, “the yield is merely a correction towards normal level.”

The International Monetary Fund (IMF) in its recent report on Pakistan criticised the central bank for directly and indirectly financing the government’s budget deficit. It termed the monetary policy “too accommodative”.

From July to March this year, the gap between national income and expenditure widened to 5.5 per cent of total national output or Rs1,153 billion, show provisional estimates.

Rates of return on treasury bills also rose last month. On three-month bills, the yield increased to 11.83%, up 23 basis points than the January rate. On six-month papers, the rate went up to 11.9%, 27 basis points higher than the previous auction.

Debt breakdown

According to official documents, domestic debt ballooned to around Rs7 trillion by end-January, a net increase of Rs953 billion since July. Of the total figure, the share of treasury bills stood at Rs2.4 trillion, a third of total debt.

Similarly, the share of market treasury bills was slightly over a fifth, standing at Rs1.4 trillion. Investment bonds made up 12% of total debt as the government borrowed Rs882 billion through auctions.

National savings schemes are the second biggest source of government borrowing. Their share was around Rs2 trillion, 29% of total domestic debt.

Published in The Express Tribune, March 16^th, 2012.