Government of Pakistan likely to reduce borrowings from Central Bank

The quantum of Government of Pakistan (GoP) borrowings from State Bank of Pakistan (SBP) has lately reached 12.6% of GDP, the highest since FY06. The limit specified by International Monetary Fund (IMF) is 7.5-8.0% of GDP. This necessitates a shift towards banks for borrowings. The latest auction of Pakistan Investment Bonds (PIB) in which yield spread rose to 2.2% can be taken as an indication of paradigm shift.

A peep into the history indicates that the stock of borrowings from SBP was at 10.0% of GDP at the time of entry into the previous IMF program that became effective in September 2013. It was gradually receded to 9.2% by FY14 end. The share of PIBs as a percentage of borrowings from banks was reported at 19.0% at the start of the program that surged to 53.4% by FY14 end.

The banking sector is likely to aggressively pursue PIB accumulation (getting a cue from the latest PIB auction), where resultantly, financing growth is expected to jot down to below 10% as compared to 14.7% CY18TD.  Banking sector would benefit from increased spread on the longer tenor bonds particularly when fresh yield on advances are bound to fall where the fall gets steeper when burdened by the cost of provisioning.

The GoPs stock of borrowings from the Central Bank has reached Rs4.8 trillion as of the latest available data, culminating into 12.6% of GDP, highest since FY06. To highlight, one of the foremost conditions of the IMF is to reduce GOP Borrowings from the Central Bank as is seen during past programs (2009 and 2014). In the last program, stock of borrowings from Central Bank stood at 10.0% of GDP at the time of entry into IMF program (September 2013) which, gradually reduced to 9.2% at FY14 end and 6.0% at FY16 end.

Taking average stock of borrowing as a % of GDP in the last two programs, which is assumed as IMF acceptable limit, banking sector analysts expect Rs2 trillion borrowings to be routed through banking channels (other than further budgetary borrowings required by the Government). In the last program, PIBs were the preferred avenue for the Government to shift budgetary borrowings to banks (PIBs as a percentage of bank borrowings stood at 19.0% at the start of the borrowings (1QFY14) and reached to 53.4% by FY14 end), for which the yield spread on 3-year PIB rose to as high as 2.5%.

Larger interest of the banking sector can be seen in PIBs this time around: The current PIB auction, though small in amount (Rs24.1 billion raised as compared to a target of Rs50 billion target), emits a strategy similar to previous paths, where yields on 3-year PIB improved to 2.2% as compared to 1.0% in PIB auctions of 2018.

Analysts expect increased participation by the banking sector once future interest rate hike expectation calms down. Analysts estimate another 150bps hike in interest rate in CY19). PIBs as a percentage of total Government borrowings from banks stands at 30.0% currently as compared to 40-50% in the last IMF program. The banking sector is likely to aggressively pursue PIB accumulation, where financing growth is expected to jot down. Hence, analysts do not rule out spread on PIB yield dragged down as competition amongst banks for deploying funds strengthens.

According to banking sector analysts, banks are expected to benefit from increased spread on the longer tenor bonds particularly when fresh yields on advances are bound to fall where the dip gets steeper with the addition of cost of provisioning. Historically, the credit spread on advances rises to average 1.5-1.6% when interest rates are below the 10% mark, beginning to weaken when crossing 10%, averaging 0.8%. This is also justified as interest rate rise, demand for financing diminishes and risk on loans increases and as such the sector competes for good lending opportunities. Analysts expect cost of provisioning to creep up to average at 0.5-1% in CY19, with augmentation apparent in 2HCY19. Hence, the sector is better placed in the current down cycle with the presence of PIBs and their consequent impact on NIMs, largely negating any increase in provisioning costs. Additionally, the sector would gain from PIB holdings as the interest rate cycle reverses through realizing capital gains on longer tenor bonds as seen between CY14to CY17.

Another Option

It seems certain that the credit lines from multilateral donors will not become available till Pakistan finalizes deal with the IMF. In the prevailing scenario, the GoP has two options, to either issue rupee denominated or dollar denominated sovereign Sukuk. Exercising this option on one hand will offer an opportunity to Islamic banks to deploy their surplus liquidity and on the other hand enable the GoP to borrow at a competitive cost.  One of the common complaints is that the central bank is keen in mobilizing funds through conventional banks and at times deprives Islamic banks from deploying their surplus liquidity. However, there is another view that Islamic banks are not keen in investing in short-term government securities.

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