NAME SEAT NO

: TEHREEM AZHAR : B1155143

ASSIGNMENT NO : 3

1.1) Pakistans central bank (State bank of Pakistan) said it would buy government paper i.e
treasury bills from commercial banks eg UBL, Habib Bank etc on Friday on in a 7 day reverse repo. Reverse repo means that the SBP would repurchase government paper from commercial banks for a period of 7 days to inject cash into the market and to reduce the liquidity problems of the commercial banks. After a period of 7 days SBP would sell those government paper again to commercial banks but at a reduced price for example if SBP had repurchased government paper at 100 Rs it would sell them back to commercial banks at 90 Rs and so commercial banks will be able to make a profit. The second paragraph says that SBP has not announced as to how much government paper it is going to repurchase from the commercial banks in this open market operation (OPO). The term OPO means the sale and purchase of government securities. The basic purpose of OPO s is to maintain the smoothness in the liquidity position of the money market. In the second line of the second paragraph it is said that the result of the auction will be announced later at 10:15 am. The term auction means over here the bid rate at which the SBP would be willing to repurchase the government paper. Furthermore it is said that settlement would be later in the day meaning that the different commercial banks whose bid was chosen or those whose bid was not chosen could come later in the day to sell their government paper or treasury bills to us. With this kind of OPO SBP is expanding the money supply in the financial market for one week. So adopting this type of policy will be called expansionary monetary policy.

1.2) Open market operations means the sale and purchase of government securities. Over
here it is said that the SBP has sold to the commercial banks or brokers treasury bills worth Rs 15 billion. It means that the commercial banks brokers has bought from SBP treasury bills worth of worth Rs 15 billion. Money worth Rs 15 billion has gone from commercial banks to the vaults of SBP. In the second paragraph it is said that the SBP has sold these treasury bills with a maturity period of one day. It means that after one day the commercial banks will sell the treasury bills back to SBP at an increased price then that at which they had bought the treasury bills from SBP. 9.9% repo rate means that the commercial banks will buy the treasury bills from SBP at 9.9 less then the face value for example if the face value of the treasury bill is Rs 100 then SBP would sell it to the commercial banks at Rs 90.1 and so the commercial banks will be able to make a profit of 9.9% on every treasury bill. SBP is doing this OPO to absorb the additional liquidity from the banking system. This means that the banks had an excess of liquidity or as it is called excess liquidity and so had more money then was required.Furthermore it is said that the commercial banks had offered to buy treasury bills worth Rs 20 billion but SBP had sold the treasury bills worth only worth Rs 15 billion .SBP had thought that this amount would stabilize the interest rate. So SBP had sold Rs 15 billion treasury bills at 9.9% repo rate and that SBP would continue to perform OPOs in future as well for soaking out the addition liquidity meaning the excess liquidity or the additional funds. SBP had first followed contractionary monetary policy over here in which it had tried to reduce the money supply and had then followed expansionay monetary policy in which it had again incresed the money supply.

1.3) State bank of Pakistan announced its first monetary policy in which its central bank of
directors decided to leave the benchmark or KIBOR interest rates unchanged at 9.5%. Benchmark or KIBOR interest rate is the interest rate at which SBP arrives after taking out the average of the interest rates given to it by various commercial banks daily. It announces this interest rate at 11:15 am . The last line of this paragraph says that SBP left that interest rate at which it had arrived by taking the average but that it did try to persuade the commercial banks for a cut in interest rates. In the second paragraph it is said that the discount rate was not changed. The discount rate is the interest rate at which SBP lend money to commercial banks when they are facing problems of liquidity or other such problems from the discount window ( The terms and conditions under which the SBP lends to depository institutions). It was expected that itv would not change and that various analysts had already predicted that it would not change and would hold steady. In the l;ast line it is said that people trading in the government bond market largely agreed with that sentiment. This means that people trading in the government bonds market donot want the interest rates to decrease because when interest rate decreases price of government bonds increases. In the third paragraph it is said that the new monetary policy is interesting because its wording seems to be implying a lot about its new board of directors. Furthermore the most obvious difference was that it was simple and did not involve a lot of bereautic language and it also strongly defended the 4.5% interest rate cut over the past 2 years. In the highlighted portion it is said that the repayments which must be paid to IMF including the upcoming 838 million will have to be paid in the coming months were the primary motives to keep the interest rates flat meaning keeping the interest rates unchanged. In the fourth paragraph it is said that the highlighted portion seems to be a whole document only a portion of which is shown over here. The first few sentences of the document showed that interesr rate cuts were defended and the positive effects of such cuts on the economy were also shown for example that if interest rates are cut then it would increase the investable funds and so investment would increase but invariably the last sentence mentioned that the result of such cutsin the interest rate could be risky to the balance of payments and the currency exchange rate if such kind of cuts wre to be continued. In the fifth paragraph it is said that SBP had wanted to cut the interest rates. Furthermore if SBP had wanted to keep the real interest rates close to zero meaning that interest rates had increased in the same proportion as compared to inflation in the economy then SBP would have supported a 1.5% interest

rate cut as the inflation rate for the first nine months was hovering around the 8% mark. Earlier in the article it was said that the benchmark interset rates were 9.5%. So if inflation rate was around 8% then the real interset rate would be zero if the interest rate was 8%. But unfortunately because of worries about repayments to the IMF including the upcoming 838 million, interest rates were kept flat meaning they were not changed. In the sixth paragraph it is said that after talking at length about how inflation has decreased it has still been decided that the interset rates will not be cut but will stay the same. In the seventh paragraph it is said that the federal government or fiscal authority is facing such difficulties because it refuses to control its spending. The high spending expenditures according to SBP is because of the increased level of subsidies that the government if providing to the population. Decrease that and most of the monetary problems of the government will go away. The government is spending more then the revenue it is generating and so if facing problems. In the eighth paragraph it is said that the Central bank (SBP) is saying that the government needs to decrease the level of subsidies it provides to the population eg Benazir Income Support Programme if it wishes to avoid economic catastrophe later. But the government should not decrease the level of subsidies immediately as this will cause a massive inflation and the prices will increase by leaps and bounds. But the government also should not act too slowly in implementing this contraction of subsidies otherwise it shall prove very difficult because it will not have any borrowing options left and to counter this would simply start printing money which would also cause inflation.Governments borrowing options are as follows: 1) It can borrow from IMF or World Bnak 2) It can borrow from foreign loanable markets 3) It can borrow from domestic loanable markets 4) It can borrow from SBP 5) It can sell government bonds 6) Others If the government simply starts printing money then inflation could increase because the increase in money supply would be more as compared to the increase in the national output.Inflation means too much money chasing too few goods and this would occur over here. In the ninth paragraph the SBP says that the open market operations which keep the liquidity situation stable in the banking system which allows the finance ministry then to take away the funds cannot be continued for a longer period of time. It is quite unsustainable for this to occur indefinitely.

In the last paragragh it is said that the banks should take this as a warning that the OMOs could end and then the government would not be there to help them with their liquidity problems meaning that the option of the discount window will be lost, so the banks should start trying to maintain their liquidity and to meet their daily cash requirements. This means that the banks would now have to maintain excess liquidity. Banks would now have to lend a smaller amount and this would decrease their profits as the banks main income comes from the interest on loans.

1.4) In the fourth article Pakistan Investment Bonds have been discussed. Bonds are of
different maturity periods viz three years, five years , seven years, ten years etc. Bonds can be purchased by indivisuals and corporate bodies including banks, irrespective of their residential status .Their is no quantitative limit on purchases. Bonds are redeemable on completion of their respective maturity period. It is said that the basis points which means the interest rate has gone up from 12.44% to 12.54%. The SBP announced this on Wednesday. 100 basis points(bps) = 1% rate of interset. This may seem like a very small amount but when you are dealing with billions of Rupees this increase of 10 bps or 0.1% interest rate can make a huge difference especially when the government will be making payments as the buyers will be increasing.The ministry of Finance sold or auctioned PIBs. Rs 10 billion flowed into the government vaults in the current time period but when these PIBS maturity period is reached then the government will have to pay Rs 10.11 billion back. According to the PIB results those bond which have a 3 year maturity period increased by 4 bps meaning the interset rate on a 3 year bond increased to 0.04% and so the interest rate increased to 12%, so the interest rate on a 3 year bond has increased from 11.96 % to 12%. For a 5 year maturity period PIB 1BPS was increased. It means that on a 5 year PIB interset rate increased by 0.01% and is now 12.407%. On a 7 year maturity PIB 7 bps was increased. It means that on a 7 year bond interest rate was by 0.07%and the new interest rate is now 12.5%. On a 15 year maturity period PIB 2bps were increased. This means that interest on a 15 year bond was increased by 0.02% and the new interest rate now is 13.099%. On a 20 year maturity period interest rate instead of increasing decreased by 11 bps. This means that on a 20 year bond interest rate decreased by 0.11 % and the new interest rate is now 13.5507%. On the 30 year maturity period bond bps decreased by 19 bps. This means that interest rate on this bond deacreased by 0.19%. So on some bonds the interest rates were increased namely on 3,5,7,10,15 and on others namely on 20, 30 years it was decreased. So on 3 year bond government will have to pay Rs 3.2 billion additional payments. On 5 year bond government will have to pay Rs1.38 billion additional payments. On 7 year bond government will have to pay Rs 0.15 billion additional payments. On 10 year bond government will have to pay RS 4.56 billion additional payments. On 15 year bond government will have to pay 0.51 million additional payments. On a 20 year bond governments payments will decrea se by0.52 million and on 30 year bonds governments payments will decrease by 0.54 millio n. It seems that the governments payments have increased more then they have been cut. Furthermore it is said that the auction was held on Wednesday and that the coupon rates for bonds were as follows:

3 Year 5 Year 7 Year 10Year 15Year 20Year 30Year

11.25% 11.50% 11.75% 12.00% 12.50% 13.00% 13.75%

You take the coopon to National Bank of Pakistan usually after 6 months or 1 year and they will pay you the interest rate on the bond. The full payment that is the bond price will be paid back to you when the maturity period is up. The settlement date is february 04 this means that this is the date on which the bonds will be available with NBP for sale. It is said that in the last PIB auction on 10 year bonds interest rate had by 6 bps meaning that on the last auction on 10 year bonds interest rate was decreased by 0.06% and that is why the total interest rate of that auction had reached 12.44%. Over here the bonds have been sold for the first time so it is called the primary market or wholesale market for such types of bonds. When they are sold again in the market then they are sold in secondary markets or retail markets. Over here it is said that the yields from the secondary markets was not that much in the beginning but then the yields increased. This means that intially the bonds were not being sold at higher prices but then the capital gain on them increased on dec 09 and the reasons for the increase are given below: 1) Delayed IMF tranche for USD 1.2 bn, received late in Dec 09. Tranche actually means the reserve tranche, because IMF member nations
have many different national currencies, the IMF denominates its members' quotas in terms of special drawing rights (SDRs), which is essentially a specified basket of major international currencies. A certain proportion of a member country's quota is specified as its reserve tranche. The member country can access its reserve tranche funds at its discretion, and is not under an immediate obligation to repay those funds to the IMF. Member nation reserve tranches are typically 25% of the member's quota. So this means that the government of Pakistan has now got more funds for payments. However this factor will raise concerns over domestic liquidity meaning the liquidity of Pakistans commercial banks is still highly dependent on external financing meaning that the government of Pakistan has failed to maintain the stability in our domestic liquidity position.

2) Higher inflation expectations for Dec 09 which remained 10.52% YoY (Year Over Year) compared to the market consensus forecast of 11.8% YoY.

The term YoY (Year Over Year) is a method of evaluating two or more measured
events to compare the results at one time period with those from another time period (or series of time periods), on an annualized basis. Year-over-year comparisons are a popular way to evaluate the performance of investments. Any measurable events that recur annually can be compared on a year-over-year basis - from annual performance, to quarterly performance, to daily performance.

This means that the inflation expectations were higher but the actual inflation which occurred was not so high. After the loans came i.e from the reserve tranche and the lower infation ,the yields had normalized from the post Dec 09 period. Future expectations about the inflation are set at a higher data meaning inflation is expected to rise in the future. This is supported by 4% MoM and an 18.4% increase in Year Over Year in SPI (Sensitive Price Indicator) from 28th January. Sensitive Price Indicator means the degree to which the price of a product affects consumers purchasing behaviors. The degree of price sensitivity varies from product to product and from consumer to consumer. In economics, price sensitivity is commonly measured using the price elasticity of demand. Widely available, homogeneous goods are more likely to exhibit high price sensitivity. For example, consumers are often not willing to pay even a few extra cents per gallon for gasoline, especially if a lower-priced station is nearby. Some consumers are more price sensitive than others. Consumers who are more frugal or who are on fixed incomes are more likely to pinch pennies and shop around for lower prices. Meanwhile, some high income consumers may feel it is not always worth their time to search for better deals on many items, and thus become less price sensitive. In the case of Pakistan It is said further that the other factor which can impact interest rates is the maintained monetary policy which probably means that there is almost an inconstant supply of money by SBP so the influence on interest rates will be because of money supply. This is also further supported by the fact that there have been recent fluctuations in aggregate monetary supply situation. SBP has positive expectations for higher NFAs (Net Foreign Assets) and SBP reserves for the second half of the fiscal year but the current money data for 23rd Jan shows divergent movement. In economics, the concept of net foreign assets relates to balance of payments identity.The net foreign asset (NFA) position of a country is the value of the assets that country owns abroad, minus the value of the domestic assets owned by foreigners. The net foreign asset position of a country reflects the indebtedness of that country.

The traditional balance of payments identity:

Traditional balance-of-payments accounting is that the change in the net foreign asset position equals the current account balance. In other words, if a country runs a $700 billion current account deficit, it has to borrow exactly $700 billion from abroad to finance the deficit and therefore, the country's net foreign asset position falls by $700 billion.

The augmented balance of payments identity: The traditional balance of payments identity does not take into account changes in asset prices and exchange rates. For example, the value of external assets or liabilities can change due to higher or lower stockmarket prices or a default/write-off on debt. Similarly, changes in exchange rates will affect the value of foreign assets and liabilities. An appreciation of a country's currency will decrease both the value of assets denominated in foreign currency and the burden of liabilities denominated in foreign currency. The value of assets and liabilities denominated in the home currency will not be affected by changes in the exchange rate. Suppose the same country has some assets it owns abroad, and the value of these assets appreciates by $700 billion. The appreciation of asset prices, referred to as "positive valuation effects" in this case exactly offsets the current account deficit. At the end of the day, the country's net foreign asset position remains unchanged, despite the $700 billion current account deficit. The effect will be the same if the value of the country's external liabilities falls by $700 billion, or the gains in value of its foreign assets minus the gains in value of its liabilities is $700 billion. The net foreign asset position equals the current account plus valuation effects: The debt payment of US debt 600 million has managed to impact the NFAs , w hile higher government borrowing requirements are once again reflected through borrowing from SBP which has increased after the quarterly review. This means that the government is borrowing heavily from the SBP for deficit financing. Furthermore the higher NFAs (Net Foreign Assets) have lent support in for growth in money aggregates which has actually posted 6.5% growth in Dec 2009. However as recent updates show Net Foreign Assets have once again shrunk to4.92%, which is in reality way shorter than expected as the expectations were that NFAs would continue to grow as high as 14.5% in the fiscal year 2010. In addition SBP said that the recent monetary policy statement pointed out that the strained market liquidity conditions in the second quarter of the fiscal year is because of the decline in Net Foreign Assets of the Banking System and substantial improvement in private sector credit. In business, economics or investment, market liquidity is an asset's ability to be sold without causing a significant movement in the price and with minimum loss of value. Money, or cash, is the most liquid asset, and can be used immediately to perform

economic actions like buying, selling, or paying debt, meeting immediate wants and needs. The Net Foreign Assets of the Banking System in the first quarter of the fiscal year 2010 had increased by Rs 34 million which is excluding SDR allocation mainly due to budgetary support of $745 million (which is approximately 62 billion) by IMF. Special drawing rights (SDRs) are supplementary foreign exchange reserve assets defined and maintained by the International Monetary Fund (IMF). Not a currency, SDRs instead represent a claim to currency held by IMF member countries for which they may be exchanged.[1] As they can only be exchanged for euros, Japanese yen, pounds sterling, or US dollars,[imf 1] SDRs may actually represent a potential claim on IMF member countries' nongold foreign exchange reserve assets, which are usually held in those currencies. While they may appear to have a far more important part to play, or, perhaps, an important future role, being the unit of account for the IMF has long been the main function of the SDR. In the second quarter of the fiscal year however because of lower budgetary support of $ 374 million (which is around 31 billion) and other foreign inflows , it resulted in net contraction of Rs 30 billion in foreign assets. Private sector credit increased by Rs 199 billion because of the modest recovery in real activity in the second quarter of the fiscal year as compared to a decrease in the first quarter of the fiscal when it had contracted by Rs 75 billion adding increased pressure on the available market liquidity. In addition it is said that the market liquidity conditions improved in the second quarter of the fiscal year because of a significant increase in total banking system deposits. But because the Public Sector meaning the government kept on borrowing from the banking systems so it continued to constrict liquidity. Also because of government borrowing by floating treasury bills to meet its budgetary requirements meaning that the government had a deficit that it covered by selling treasury bills. The trends in both the public and the private sector credit constricted the markets liquidity and with a Price Investment Bonds auction of Rs 30 billion liquidity conditions are most probably likely to remain tight for the rest of this fiscal year. So a retirement of commodity financing (International financial transactions are based on several financing philosophies, whose application is affected by the course of economic growth and development within an individual national economy. This is demonstrated by the evolution of the financing technique known as International structured trade & commodity finance), complete resolution of circular debt ( Circular debt is a situation in which a string of debtors and creditors exist in a fashion such that the net final creditor is called debt. Circular debt is when, to give a three-person example, A owes B, who owes C, who owes A),and the realization of projected foreign inflows(In economics, capital inflow is the amount of capital

coming into a country, for example in the form of foreign investment. ) will play a crucial role improving market liquidity conditions.