Download Open Market Operations and the Treasury Bills

Open Market Operations and the Treasury Bills Auction
Ivy Aryee
Centre for Policy Analysis
CEPA, Accra
June 2001
Introduction
Every Friday the Bank of Ghana (BOG) conducts an auction of T-bills on behalf of
government in respect of the Government of Ghana’s (GOG) Public Sector Borrowing
Requirement (PSBR) and of itself as an instrument of monetary policy. It is a wholesale
auction with only primary dealers as participants. Primary dealers comprise Domestic
Banks (DMBs) and some non-bank financial institutions like discount houses and brokerage
firms. The primary dealers participate by submitting competitive tenders at the auction. The
BOG pays a commission fee of 0.25 percent of the face value for securities purchased by
the primary dealers on behalf of their customers.
After the auction, tap sales are used to supply customers outside Accra through the BOG’s
branches in Kumasi, Takoradi, Hohoe, Tamale and Sunyani. Securities for the tap sales are
purchased by the BOG in a non-competitive tender and sent to the regional branches.
The Auction Committee
The Auction Committee comprises representatives from the BOG, Ministry of Finance
(MOF) and Controller and Accountant General’s Department (CAGD). It meets every
Friday. It has a two-fold purpose:
To determine the lowest acceptable price for each T-bill that will be accepted from
the bids submitted, and hence the highest interest rate that will be allowed that
week; and
To determine the total value of T-bills that will be offered at the next auction, based
on the PSBR and the BOG’s desired level of OMO.
The OMO Committee
There is an OMO Committee that meets every Thursday to determine the size and direction
of the weekly OMO. That is whether reserves need to be added or drained from the banking
system. The size of OMO arrived at is governed by the difference between actual reserves
and the weekly reserve money target. Quarterly targets are agreed with the IMF (as
benchmarks or performance criteria under the PRGF formerly ESAF Arrangement). These
are broken down into weekly targets using straight-line projections by the Research
Department of the BOG. The DMBs submit formal reports on their reserve positions every
Wednesday. In practice, the BOG canvasses DMBs daily to determine their overall reserve
position. Thus, even though formal reports on reserves are submitted by the DMBs once a
week, the BOG has a reasonably good idea of the level of reserves in the banking system on
a continuous basis.
The OMO Committee weighs current and potential changes in all sources of change in
Reserve Money namely, BOG’s holdings of GOG securities, Net Foreign Assets, Net
Claims on GOG and Net Claims on the Rest of the Economy (including the financial
sector). This enables the Committee to make an informed judgement of how the monetary
base, that is Reserve Money, is likely to behave in the near term. Based upon these
considerations the Committee presumably decides on the volume of OMO that would be
undertaken from week to week. The BOG is thus, in a position to know whether it has met
the targets set for itself or even more critically those agreed with IMF.
The target for the week thus determined by the OMO Committee is a key input in the
determination of the total value of T-bills that the Auction Committee would offer at the
subsequent auction ― the other determining component being the PSBR from the cash flow
of the GOG prepared by the MOF.
Fully Subscribed Outcome
The GOG has first claim on the OMO proceeds, which it uses to meet its PSBR. The Bank
of Ghana Law (1992) among other things specifies the BOG’s obligations as the
government’s banker and fiscal agent. Part I, Section 3(c) enjoins the BOG to regulate and
direct credit of the banking system in accordance with the economic policy of the
Government. This clearly subordinates the regulation of credit to the economic priorities of
the government ― priorities which may conflict with the broader objectives of achieving
and maintaining macroeconomic stability, specifically low rates of inflation. Consequently
it is the residual proceeds that constitute the means of draining reserves from the banking
system to meet the Reserve Money target. It is these residual (after the GOG’s claims for
meeting PSBR has been met) proceeds, if any that constitutes the BOG’s OMO in
government securities. The BOG could and does resort to Foreign Exchange Market
Operations (FEMO) i.e. sale of foreign exchange as additional means of achieving the
reserve money target.
The total value of GOG securities sold at the auction becomes a claim on the GOG in the
balance sheet of the BOG. The gross assets of the BOG are unaffected by the OMO.
Instead, changes in bank reserves (a BOG liability) are offset by an increase in the value of
a blocked account of the GOG held by the BOG. In other words, the component of the
auction proceeds earmarked to meet the PSBR is recycled back into the system and if the
auction is fully subscribed, has no significant effect on the balance sheet of the BOG. The
residual proceeds, (technically the OMO component), are deposited into a GOG blocked
account. The effect of this is a reduction in bank reserves (and hence reserve money) but
with a corresponding reduction in the net claims on the GOG as the blocked account rises.
Undersubscribed Auction
As depicted in Figure 1, the auction is more often that not undersubscribed ― sale/offer
ratio less than unity. Undersubscription, given the first claim of the GOG, means that the
OMO fails to achieve its objective and the reserve money target for the week cannot be
fully met through the T-bills auction. FEMO or reverse REPO or both may therefore be
needed.
If the extent of undersubscription reaches the point where the PSBR cannot be met, a
serious problem of macroeconomic stability arises. Various courses of action include:
BOG purchase of enough T-bills to meet the PSBR. This granting of credit to
government by the BOG creates money as the financing of the PSBR means
payments for goods and services by government and or the redemption of maturing
securities. The BOG is not only unable to conduct its OMO, but also directly
violates its reserve money target.
Table 1 presents a bar chart frequency distribution of subscription rates for the period 1995
to mid-2001. The overall average is 74.1% with a median of 85.6% and a modal class of 8190%. It is clear that on average the BOG’s OMOs have failed because the T-bill auctions
have been persistently undersubscribed. Furthermore the BOG has often extended credit to
government, offsetting the potentially, inflationary effects of such monetary injection by
running down its holdings of international reserves. When this latter route proves infeasible,
payment arrears have resulted. It is estimated by CEPA that as at end-December 2000 the
stock of payments arrears amounted to about 3% of GDP contributing to the emergence of
the domestic debt as the most difficult challenge policy facing the Kufuour administration.
Debt repudiation or cancellation, as the HIPC Initiative demonstrates, is possible (even if at
some cost) but in the context of the domestic debt can only spell disaster.
Table 1: Frequency Distribution of Subscription rates for the period ‘95–Mid 2001
Frequency
Mean
Median
Under 20%
1
21 – 30%
2
24.8
24.8
31 – 40%
3
36.3
37.9
41 – 50%
2
41.4
41.4
51 – 60%
5
54.9
52.7
61 – 70%
12
65.6
66.3
71 – 80%
14
73.1
72.3
81 – 90%
18
85.5
85.6
90 – 100%
16
95.4
94.9
Source: Calculated from BOG Auction data
Undersubscription could occur for seasonal reasons such as when income taxes are due and
around major festivals like the X’mas and New Year period. The primary reason by far,
however, is that interest rates are not free to equilibrate the quantity of securities supplied
with the quantity demanded. As Figure 2 shows ― for example over the first five months
of the year ― nominal interest rates remained stable even in the face of large swings in
subscription rates. Unofficially it is alleged that a critical consideration in the setting of
interest rates is the debt servicing cost to government.
There is an additional consideration believed to have been important in a politically
sensitive period like election year 2000. This is the political cost of the high lending rates of
DMBs. More generally it appears that interest rates are changed when reserve money
targets cannot be met through the use of alternative instruments or when other
considerations dominate. For example, beginning in the last quarter of 1999 interest rates
were raised incrementally to over 45% in an attempt to rein in the fast depreciating cedi. It
has indeed been claimed that the current relative stability of the cedi in the foreign
exchanges is due to the raising of interest rates.
An undersubscribed auction renders the BOG unable to drain the desired level of reserves
from the banking system. The historical record shows that BOG cannot exercise the degree
of control over the monetary base through the use of its primary monetary policy instrument
― the OMO ― in the prevailing circumstances. This situation at least in the past is due to
an institutional weakness that is the underdevelopment of a secondary market for T-bills
where the BOG can freely buy or sell exactly the amount of T-bills it wants to (as obtains
for example in the US). The BOG has made some progress in this direction ― converting
the auction from retail to a wholesale market by selling to only primary dealers. The latter
are in turn supposed to rediscount the securities to retail purchasers. It may be worth
recalling that originally, the discount houses were intended to underwrite the T-bill issues
and then resell them to the rest of the market. It soon became apparent that the discount
houses were not financially strong enough to do this so the BOG was forced to move to the
primary dealer system.
The important point to emphasize is that a well-functioning secondary market can never
develop as long as the need to intervene in the market to constrain the interest rate remains
strong. DMBs are apparently notified by the BOG when it deems it desirable that they raise
bid prices to lower interest rates. The BOG reportedly also uses dummy bids to signal when
it deems it acceptable for dealers to offer lower prices ― demand higher interest yields for
T-bills.
© Copyright CEPA 2002