After an unexpected increase in cut-off yields in last T-Bill auction on December0 1, 2021, money market yields have been on a rising trend recently.
Bond yields are up 136-144bps since SBP increased the policy rate by 150bps on November 19, 2021. Since the last PIB auction on November 29, 2021, bond yields on 3-5 year PIBs are up around 50bps to 11.89% and 11.91%, respectively. In 2021 to date, bond yields on 3-5 years bonds are up 362bps and 266bps, respectively. This is on expectations of further rate hike going forward on the back of rising inflationary pressures and import bill.
We believe this development can have implication on Pakistan’s banking sector. As per calculations and channel checks, around 46% of sample banks’ investments is in PIBs whereas around 18% of the investment is in fixed coupon PIBs.
We believe that banks with higher fixed rate PIBs and duration will be losers in such a scenario as their rates are locked in for higher duration in an increasing interest rate scenario as it will impact their net interest margins and profitability. Our channel checks suggests that the average duration of sample banks for fixed rate PIBs is around 2-3 years and their investments is locked in at an average of 8-10% compared to current yields of 12%.
On other hand, banks with higher current account deposits, higher T-Bill & advances concentration and lower fixed rate PIBs/duration are likely to be gainers in rising interest rates.
Furthermore, rise in bond yields could also result in revaluation losses for banks on investments classified as ‘Available for sale Investments (AFS)’ as bond prices and bond yields are inversely related. This may not only impact bank’s equity/book value but may also result in lower capital adequacy ratios (CAR) for the banks.
Future interest rate movement
According to Reza Baqir, Governor, State Bank of Pakistan (SBP), having opted for Asia’s boldest hikes since September 2021, Pakistan’s central bank is not likely to announce hike in interest rate in the near term to maintain economic recovery.
In an interview with Bloomberg, the SBP Governor said that the SBP believes a coordinated macroeconomic response will be the most important factor in sustaining recovery and keeping inflation in check.
He stated, “We are going to take a pause to first look at the effects of the tightening we have already done.”
The central bank Governor elucidated, Fiscal policy has been very complimentary and is also withdrawing stimulus, therefore a coordinated macroeconomic response will be number one priority to sustain recovery and keep inflation broadly in check.”
Baqir believes that a larger current-account deficit, inflation, and greater economic growth could prompt the SBP to continue rate hikes. However, despite the rate hikes, Baqir forecasts the economy to grow 5% in the fiscal year ending in June 2022, up from 4% in the last year. He remarked that the pressure on the PKR will ease as demand for USD falls in Pakistan’s local market.
Notably, the SBP has raised interest rates by a total of 275 basis points thrice in quick succession since September to cool the region’s headline inflation and close a US$5 billion deficit in November’s current account.
This has weighed heavily on PKR, which has been the weakest performer among 13 Asian currencies monitored by Bloomberg for the past six months.
PKR has witnessed almost 13% erosion in vale against USD on a fiscal-year-to-date basis after recording another historic low of PKR177.98 against USDlately. Moreover, Pakistan’s liquid foreign reserves eroded by US$90 million on account of debt servicing during the week ended on December 10, 2021. In order to minimize the pressure of foreign exchange outflows, the country needs to explore other avenues to build reserves and potentially support the depreciating PKR.
T-Bills Auction
Pakistan Government of Pakistan (GoP) raised Rs1.3trillion in a crucial T-Bills auction where cut-off yields remained almost flat. Due to year end and ahead of resumption of IMF program, auction was important for interest rate direction for local markets. The GoP had to borrow (auction target) a huge amount of Rs1.4trillion in this auction which made it even more important at a time when interest rate are rising in Pakistan and borrowing from Central Bank is restricted due to IMF conditions. In the latest auction Government raised Rs1.3 trillion against an indicative target of Rs1.4 trillion and maturity of Rs1.5 trillion.
Unlike last auction when government borrowed aggressively, in this auction they borrowed Rs1.3trillion where cut-off yields remained flat. In 3-months, government borrowed Rs805 billion at cut off rate of 10.78% while in 6-months it borrowed Rs385 billion at 11.5% and 12-month Rs95 billion at 11.51%.
SBP in its latest Monetary Policy Statement (MPS) had said that the sharp increase in cut-off yields in last T-Bill auction was unwarranted. After Monetary Policy announcement, secondary market rates also came down by 25-28bps as 6-month T-Bill and 6-month kibor rate clocked in at 11% and 11.26%, respectively. Another large T Bill auction is scheduled on December 29, 2021 when GoP is targeting to borrow Rs1.2 trillion with maturity of Rs1.1 trillion.