Econ666: Liquidity Crisis in Pakistan

If the possibility of default is not enough to give jitters to Pakistanis, now they also have to worry about liquidity in inter-bank market so that banks might not collapse.

Due to the limits imposed on foreign investments for commercial banks, Pakistani banks are not exposed to subprime crisis in US. However, we have our very own subprime crisis lurking in the shadows due to runaway consumerism such as car loans, credit cards, personal loans and mortgage finance at a scale never seen before. More on consumer debt in later articles.

Its amazing how the current economic managers (Shamshad Akhtar – SBP governor, Shaukat Tareen – Advisor to Finance Minister) are actually ending up screwing the economy. Though SBP by reducing CRR by 100bps has managed to alleviate the situation and proven me wrong, what remains to be seen is what actually caused the crisis. What is amazing is that everyone is to blamed for this crisis as the players range from housewives to finance supremo.

One, It has been claimed by SBP that the liquidity shortage was because of Eid withdrawals. If that is the case then I am really amazed at naivete of the banks  and SBP. Its not like Eid is once in a decade event. Its an annual event. If the banks have not learnt to manage their liquidity during Eid and that is the real reason, then the bank management or at least their treasury should be fired.

Two, rumor mongering and a possibility of default which might lead to free fall in rupee had housewives withdrawing their rupee deposits from banks and converting them to US dollars. The matters were not help by shortage of cash at some branches as no branch is ready for huge withdrawals However, the problem was exacerbated when rumors started flying that certain banks are about to default such as Bank Al Falah etc.

Three, we all know that government is borrowing hugely from SBP and SBP has been raising a flag on the budget deficit for sometime. So what does our advisor Shaukat Tareen decide to do. Rather than cut spending to reduce deficit, he asks Public Sector Enterprises (PSEs) to withdraw deposits and uses those for spending. SBP actually agreed to this proposal. Worst kind of window dressing (voodoo economics) that is possible. Banking system was suddenly hit with huge withdrawals adding to the shortage of liquidity.

Four, its known that inflation is high and controlling inflation is on the agenda of SBP. The monetary policy measures taken by SBP can affect demand pull inflation but they hardly go anywhere in controlling cost push inflation. Nevertheless SBP had been conducting treasury auctions regularly to drain liquidity from the market. If it had any effect on inflation, remains to be seen. What is most shocking was that SBP had also conducted a treasury auction on October 8th, 2008 when the liquidity problem was most acute.

Thankfully, SBP came to its senses and reduced CRR by 100bps which brought in much needed liquidity into the banking system. However, the way the above events have played out, it does not give people much confidence in the financial sector or the economic managers of the country.

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