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COMMON MARKET FOR EASTERN
AND SOUTHERN AFRICA
19th Meeting ofCOMESA Committee of
Finance and Monetary Affairs
24 – 26 November, 2013
Lilongwe, Malawi
PROPOSAL FOR APPROPRIATE MONETARY POLICY
REGIMES FOR COMESA REGION
By: Ibrahim A. Zeidy, Nicholas Korir, Zorodzo Chuma
2013 (IZ-mkc)
1
Table of Contents
Background…………………………………………………………………………………………..……4
Objectives of Appropriate Monetary Policy Framework……………..…………………………...…..5
Review of alternative Monetary Policy Frameworks……………..………………….………………..5
Exchange Rate Targetting……………..………………………………………………………………..6
Monetary Targeting…………………………...…..…………………………...…..…………………….7
Inflation Targeting…………………………...…..…………………………...…..………………………8
Table 1…………………………...…..…………………………...…..…………………………...………8
The Pros and Cons of Alternative Monetary Policy Regimes…………………………...…………..8
Table 2……………………………………………………………………………………………………9
Advantages of Indirect Monetary Poliy Instruments…………………………...…..………………..12
Criteria for Determining the Instrument Mix…………………………………………………………..13
Table 3……………………………………………………………………………………………………14
Insulate Monetary Policy From Deficit Financing…………………………...…..…………………...15
Strengthen and Integrate Money Markets…………………………...…..…………………………...16
Foster Competition in the Banking Sector and Restrusutre the Banking Sytem…………………16
Adapt Supervisory and Regulatory Framework to Market Conditions……….……………………16
Bolster the Technical Capacity of the Central Bank…………………………………………………16
Key Global Challenges in the design and Implmentation of Monetary Policy…………………….17
Analysis of Monetary Policy Frameworks in Seleteced African Countries………………………..19
Table 4……………………………………………………………………………………………………19
Performances of the Existing Monetary Policy Regimes in Select COMESA Countries………..20
Table 5……………………………………………………………………………………………………22
Proposal for Approrpaioate Monetary Policy Regime for COMESA Countries…………………..33
Implementing Indirect Instruments of Monetary Policy……………………………………………...33
2
Undertake Key Concomitant Refoms to Minimize Difficulties of Implmenenting Indirect Policy
Instrusments…………………………...…..…………………………...…..…………………………...34
Careful Sequencing Based on Country Specific Circumstances of the Path for Introduction of
Indirect Monetary Policy Instruments…………………………………………………………………35
Develop a Communication Strategy that Enhances Transparency of Monetary Policy…………35
Bibiliography……………………………………………………………………………………………..36
Annex 1…………………………………………………………………………………………………..38
3
Back ground
1.
COMESA has a programme of monetary cooperation, which will culminate in Monetary
Union. The mandate to set up a Monetary Union in COMESA is derived from Article 4 (4) of the
COMESA Treaty signed in Kampala, Uganda on 5th November, 1993, which states that the
COMESA Member States shall “in the field of monetary affairs and finance, co-operate in
monetary and financial matters and gradually establish convertibility of their currencies and a
payments union as a basis for the eventual establishment of a monetary union”. This mandate is
further reinforced in Articles 76-78 which respectively deal with the COMESA Monetary and
Fiscal Policy Harmonization (MFHP), establishment of currency convertibility and formation of
an exchange rate union.
2.
COMESA has agreed on a specific time lines for the establishment of the monetary
union among its member countries. To that objective, it has instituted monetary convergence
programme and prescribed convergence criteria to be observed by member countries during
various stages on the road towards monetary union. One of the prerequisites to achieve faster
convergence is the designing of an appropriate monetary and exchange rate policies framework
for the region.
3.
In order to enhance the COMESA monetary integration agenda, the COMESA
Committee of Governors of Central Banks set up a COMESA Monetary Institute (CMI), in order
to undertake all activities related with making the region zone of macroeconomic and financial
stability and to ultimately achieve monetary union. The Institute became operational in March
2011. One of the key functions of CMI is the design of an appropriate monetary and exchange
rate policies framework for the region.
4.
This paper is prepared based on the decision of the COMESA Committee of
Governors of Central Banks in their 18th Meeting which was held in December 2012, in
Kigali, Rwanda in which they instructed COMESA Monetary Institute to undertake a study on
Appropriate Monetary Policy Regimes Targeting Single Digit Inflation for the COMESA region.
5.
The key objective of the paper is, therefore, to contribute for enhancing monetary
integration in the COMESA region by making recommendations, which will lead to the design of
the appropriate monetary policy regime in member countries of the region.
6.
In what follows, section one presents objectives of appropriate monetary policy
frameworks. Section two reviews monetary policy frameworks. Section three elaborates on the
pros and cons of alternative monetary policy regimes. Section four discusses issues related with
introducing indirect monetary policy instruments. Section five highlights pros and cons of
different indirect monetary policy instruments. Section 6 presents supporting actions to facilitate
effective use of indirect monetary policy instruments. Section seven highlights the challenges of
monetary policy regime in a period of uncertainty. Section eight analyses monetary policy
frameworks in selected African countries. Section nine presents performance of existing
monetary policy regimes in selected COMESA member countries. Finally, proposal for
appropriate monetary policy regimes for COMESA member countries will be made.
4
Objectives of Appropriate Monetary Policy Framework
7.
Monetary policy is the major component of economic policy in market economies. The
central bank is assigned the primary responsibility for conducting monetary policy and often for
formulating it. In addition, some auxiliary functions of central banks-notably, promoting the
development of the money market, safeguarding the payments and clearing system, and
performing bank regulation and supervision-support the main function.
8.
The basic policy objectives of a central bank operating in a market economy with its own
currency is generally considered to be the stability of the nation’s currency. This represents an
evolution from past practices, which gave more prominence to other objectives of monetary
policy –including rapid economic growth and a low unemployment rate. In practice, attempts to
use monetary stimuli to promote economic growth directly frequently ran into problems.
Typically, the stimuli increased the rate of growth in the short run at the cost of an undesirable
rise in inflation, balance of payments difficulties, and a lower rate of growth in the longer term.
Hence, during the last decade, there has been increasing agreement that monetary policy can
best promote medium and longer-term growth by maintaining overall price stability.
9.
However, the central bank is also concerned with the stability and efficiency of the
financial sector. As the leading financial institution, it is concerned with the efficiency of
intermediation between savers and investor, which takes place via the financial system and
contributes to economic growth. Moreover, the structure and development of financial markets
affect the transmission and impact of central bank policies, which are implemented through
those markets. Indeed, in view of these operational linkages, significant changes to the
monetary policy framework require parallel measures aimed at the structure and development of
financial markets. Full open market operations do not work well, for example, unless the money
and interbank markets function effectively.
10.
In the case of Regional monetary integration, the objective of appropriate monetary
policy framework in member countries is to achieve enhanced macroeconomic convergence.
These policies ensure the viability and sustainability of the monetary integration agenda by
making the region zone of macroeconomic stability. This in turn will enable member countries to
maintain their relative competitiveness.
Review of Alternative Monetary Policy Frameworks
11.
A monetary policy framework is an institutional arrangement under which monetary
policy is formulated and implemented. All contemporary monetary policy frameworks establish a
credible nominal anchor for domestic prices. They differ in terms of the choice of anchor and, as
a consequence, choice of instruments, mode of operation (for example, rules versus discretion)
and communication and engagement. They also differ in terms of how and how far concerns
about other objectives are reconciled with inflation objectives.
12.
A nominal anchor is a variable the central bank uses to discipline its policy decisions and
convince agents in the economy that it is committed to and can deliver price stability. It not only
helps tie down inflation expectations directly through its constraint on the value of domestic
money but more importantly provides a discipline on policy making that avoids the timeinconsistency problem1 of monetary policy.
“The time-inconsistency problem arises because there are incentives for a policymaker to pursue short-run objectives even though
the result is poor long-run outcomes which result from forward-looking behavior on the part of economic agents. Expansionary
monetary policy will produce higher growth and employment in the short-run, and so policymakers will be tempted to pursue this
1
5
13.
While the choice of monetary policy framework by a country depends on economic,
financial, and institutional environment within which policy operates apart from other constraints
in policy formulation, the choice of exchange rate arrangement by a country determines the
degree of independence of its monetary policy. There are at least three alternative monetary
policy frameworks that countries have adopted. These are:
Exchange Rate Targeting
14.
This entails fixing the price of the domestic currency in terms of another country’s
currency (or a basket of other countries’ currencies) to inherit the properties of the underlying
nominal anchor of the anchor country. This means that monetary and fiscal policies are
conducted to sustain that fixed exchange rate. The monetary authority therefore stands ready to
buy or sell foreign exchange at given quoted rates to maintain the exchange rate at its
predetermined level or within a range (the exchange rate serves as the nominal anchor or
intermediate target of monetary policy). This monetary policy framework is employed by
countries with the following exchange rate regimes:
 No separate legal tender (i.e. official dollarization);
 Currency Board Arrangements;
 Fixed pegs with or without bands;
 Crawling pegs with or without bands.
15.
Annex I shows that at least 115 countries use the exchange rate as a nominal anchor as
indicated below:
a) Exchange arrangements with no separate legal tender – At least 10 countries have
either the US currency or the euro circulating as their sole legal tender. Those with the
US dollar circulating as the sole legal tender are Ecuador, El Salvador, Marshall Islands,
and Federal States of Micronesia, Palau, Panama, and Timor-Leste. Those with the
Euro circulating as the sole legal tender are Montenegro, San Marino and Kiribati.
b) Currency Board Arrangement – At least 13 countries have adopted a Currency Board
Arrangements. Of these 13 countries, 8 including one from COMESA have a monetary
regime that is based on an explicit legislative commitment2 to exchange their domestic
currency for the US dollar at a fixed exchange rate. The eight countries are: Antigua and
Barbados, Djibouti, Dominica, Grenada, Hong Kong SAR, St. Kitts and Nevis, St.
Lucia, and St. Vincent and the Grenadines. The remaining five countries, namely Bosnia
and Herzegovina, Bulgaria, Estonia, Lithuania, and Brunei Darussalam have a monetary
regime that is based on an explicit legislative commitment to exchange their domestic
currency for the Euro at a fixed exchange rate.
policy even though it will not produce higher growth and employment in the long-run because economic agents adjust their wage
and price expectations upward to reflect the expansionary policy. Unfortunately, however, the expansionary monetary policy will
lead to higher inflation in the long-run, with its negative consequences for the economy”. Mishkin, 1998:1
2
This implies that domestic currency will be issued only against foreign exchange and that it remains fully backed by foreign assets,
eliminating traditional central bank functions, such as monetary control and lender-of-last-resort, and leaving little scope for
discretionary monetary policy.
6
c) Other Conventional Fixed Peg Arrangement – At least 68 countries have pegged their
currencies at fixed rates to either the US dollar or the Euro or a basket of currencies,
where the basket is formed from the currencies of major trading or financial partners and
weights reflect the geographical distribution of trade, services, or capital flows. Of the 68
countries, 36 and 16 have respectively pegged their currencies at a fixed rate to the US
dollar and the Euro. Those that have pegged their currency to a basket of currencies are
seven as shown in the annex.
d) Pegged Exchange Rate Within Horizontal Bands – Few countries are implementing
pegged exchange rates within horizontal bands where the value of the currency is
maintained within certain margins of fluctuation. It also includes arrangements of
countries in the exchange rate mechanism (ERM) of the European Monetary System
(EMS) that was replaced with the ERM II on January 1, 1999. There is a limited degree
of monetary policy discretion, depending on the bandwidth. The three countries are:
Slovak Republic, Syria, and Tonga.
e) Crawling Peg – At least 8 countries have adopted crawling pegs where the currency is
adjusted periodically in small amounts at a fixed rate or in response to changes in
selective quantitative indicators, such as past inflation differentials vis-à-vis major trading
partners, differentials between the inflation target and expected inflation in major trading
partners. The eight countries that include one in COMESA are: Bolivia, China, Ethiopia,
Iraq, Nicaragua, Uzbekistan, Botswana, and Iran.
f) Crawling Band – Costa Rica and Azerbaijan are the only two countries that have
crawling bands, implying each currency is maintained within certain fluctuation margins.
The degree of exchange rate flexibility is a function of the bandwidth. The commitment to
maintain the exchange rate within the band imposes constraints on monetary policy, with
the degree of policy independence being a function of the bandwidth.
Monetary Targeting
16.
This entails dealing with a domestic monetary anchor i.e. targeting the growth of a
nominal aggregate such as money supply (for example, reserve money and broad money) or
nominal incomes. To attain the intermediate target and ultimate objectives of monetary policy,
an operational framework is adopted that specifies operational variables of the monetary policy.
17.
Under monetary targeting framework, a stable relationship is assumed between inflation
and a chosen monetary aggregate. Under this framework, monetary policy may aim at
controlling the interest rates or monetary base of the banking system. In the case of the former,
interest rates are used as a policy variable and control of inflation is the ultimate objective while
broad measure of money or exchange rate is the intermediate target. The central bank affects
the level of short-term interest rates by its discount policy, supplemented by open market
operations to influence money supply. In the case of the latter, the monetary aggregates are
controlled through making changes to monetary base of the banks. In this case, the interest
rates are not used as policy instruments and are instead allowed to fluctuate according to
market forces. The policy instrument under these conditions is then primarily bank reserves
requirement. The monetary authority uses its instruments to achieve a target growth rate for a
monetary aggregate, such as reserve money, M1, or M2, and the targeted aggregate becomes
the nominal anchor or intermediate target of monetary policy.
18.
Most of the COMESA member countries fall under this framework. Most of these
countries have managed floating exchange rate regimes with no predetermined path for the
exchange rate. This means that the monetary authority attempts to influence the exchange rate
without having a specific exchange rate path or target.
7
Inflation Targeting
19.
Inflation targeting involves a public announcement of medium-term numerical targets for
inflation, with a commitment by the monetary authority to achieve these targets. It also includes
an active and effective communication with the public and the financial markets about the plans
and objectives of monetary policy makers and increased accountability of the central bank for its
inflation objectives. Monetary policy decisions are guided by the deviation of forecasts of future
inflation from the announced inflation target, with the inflation forecast acting (implicitly or
explicitly) as the intermediate target of monetary policy.
20.
Annex I shows that at least 45 countries in the world use inflation targeting as a
framework for monetary policy. None of these countries are in COMESA. Majority of them are
either developed or emerging economies. Most of them have adopted independently floating
exchange rate regimes. The rest have managed floating exchange rate regimes. South Africa,
Ghana, is among the few countries in Africa that have adopted inflation targeting monetary
policy framework.
21.
Table 1 below summarizes the main objective, intermediate target, operating target and
main instruments of the alternative monetary policy regimes.
Main objective
Intermediate
Target
Inflation forecast
Inflation
Price stability
Targeting
Exchange Rate Exchange Rate
Targeting
Stability
Monetary
Price Stability
Monetary
Targeting
aggregates
Operating
Target
Short term rate
Exchange Rate
Reserve Money
Main
Instrument
OMO; FX
Operations
OMO; FX
Operations
OMO, FX
Operations
The pros and cons of Alternative Monetary Policy Regimes.
22.
The pros and cons of the various monetary policy regimes are summarized in tables
below:
8
Table 2: Pros and Cons of Different Monetary Policy Regimes
Regime
Exchangerate
pegging
Pros
Cons
(i)
Easily understood by the public.
(ii)
Given full support by monetary policy, an
unchanged peg will over the long run
produce the same rate of inflation as in
the country of the currency peg
(iii)
Simple and transparent
(i)
Loss of monetary policy
autonomy leaves the policy
maker unable to respond to
developments
in
the
domestic economy that are
not present in the country to
which the currency is
pegged
(iv)
A visible and easily monitored anchor for (ii) With open capital markets,
price expectations.
causes domestic interest
rates to be closely linked to
(v) Fixes the inflation rate for internationally
those of the anchor country.
traded goods, and thus directly
The
targeting
country
contributes to keeping inflation under
therefore
loses
the
ability
to
control
use monetary policy to
respond to domestic shocks
(vi) Anchors inflation expectations to the
that are independent of
inflation rate in the anchor country.
those hitting the anchor
(vii) Provides an automatic rule for the
country
conduct of monetary policy that avoids the
(iii) Shocks to the anchor
time-inconsistency problem.
country
are
directly
o It forces a tightening of monetary
transmitted to the targeting
policy when the domestic currency
country because changes in
tends to depreciate or a loosening of
interest rates in the anchor
policy when the domestic currency
country
lead
to
a
tends to appreciate.
corresponding change in
interest
rates
in
the
o Monetary authorities no longer have
targeting country
the discretion that can result in the
pursuit of expansionary policy to (iv) Leaves the country prone to
obtain employment gains which lead
speculative attacks on the
to time-inconsistency
currency.
(v) An exchange rate peg that
is not fully supported by
monetary policy and by
fiscal
discipline
may
presents a number of
drawbacks:
o
9
Excessive
monetary
expansion or fiscal laxity
will
increase
inflation
pressures.
Non-tradable
prices will rise relative to
tradable prices, held down
Table 2: Pros and Cons of Different Monetary Policy Regimes
Regime
Pros
Cons
by foreign competition.
Eventually, the deterioration
in
international
competitiveness leads to
external current account
imbalances.
Monetary
targeting
(i)
(ii)
(iii)
(iv)
(v)
(vi)
o
Individuals and firms will try
to shift out of the domestic
currency
into
foreign
currencies,
leading
to
capital outflows and/or a
parallel exchange rate that
is more depreciated than
the official rate.
o
Given limited official foreign
exchange reserves, the
authorities may resort to
rationing
of
foreign
exchange, opening
the
door to favoritism in its
allocation and corruption,
and
inefficiencies
as
imports
of
necessary
intermediate inputs are
curtailed
Monetary targets are simple and (i) Depends on the relationship
transparent i.e. easy to follow, and require
between
the
targeted
no sophisticated models or techniques
aggregate and the goal of
monetary policy remaining
Enables a policy-maker to take account of
stable, and the aggregate
domestic developments when setting
being controllable by the
policy
central bank. The failure of
these conditions in a large
Easy to assess performance.
number of countries has led
to
the
widespread
Published monetary aggregate vis-à-vis
abandoning of monetary
the target gives public signal on the
targeting
stance of monetary policy.
Signals help fix inflationary expectations (ii) Money demand has proved
unstable in many countries,
that help produce lower inflation.
limiting its usefulness as an
indicator of the appropriate
Allows for accountability in case of
10
Table 2: Pros and Cons of Different Monetary Policy Regimes
Regime
Pros
Cons
monetary policy mistakes.
stance of monetary policy
(vii) A target for monetary aggregate growth (iii) Requires strong and reliable
provides a nominal anchor that is easy to
relationship between the
be communicated to and understood by
goal variable and the target
the public.
variable
(viii) Enables the monetary authorities to (iv) Other related challenges
choose goals for inflation that may differ
include:
from those of other countries and allows
o Instabilities in the money
some response to output fluctuations.
multiplier;
(ix) Like an exchange-rate target, information
o Interest rate volatility;
on whether the central bank is achieving
its target is known almost immediately
o Problems in forecasting
Announced
figures
for
monetary
liquidity;
aggregates
are
typically
reported
periodically with very short time-lags.
o Choice
of
reserve
Thus, monetary targets can send almost
aggregates for targeting;
immediate signals to both the public and
markets about the stance of monetary
o Limited and inflexible
policy and the intentions of the
monetary
policy
policymakers to keep inflation in check.
instruments.
Inflation
targeting
(x)
Monetary
targets
promote
almost
immediate accountability for monetary
policy to keep inflation low and so
constrain the monetary authorities from
the time-inconsistency trap
(i)
Enables monetary policy to focus on (i)
domestic considerations and to respond
to shocks to the domestic economy.
(ii)
Velocity shocks are largely irrelevant as
the monetary policy strategy no longer
relies on a stable money-income
relationship. Thus, unlike monetary
targeting, stability of the relationship
between the monetary aggregates and
income is not essential as it focuses
directly on the final goal – inflation.
(ii)
(iii)
By allowing policy to respond to all
available information – and not just to the
monetary aggregates – an inflation target
allows discretion at the level of
interpreting information. i.e. allows the
monetary authorities to use all available
11
Difficulty
of
directly
controlling inflation.
The long and variable lags
in monetary policy and the
absence of a simple rule
may make it difficult for the
public to monitor the
performance of the central
bank in a timely manner. IT
is especially difficult in
emerging
market
economies
because
inflation is hard to control
and there exist long lags
between the adoption of
monetary policy instruments
and the inflation outcome
Table 2: Pros and Cons of Different Monetary Policy Regimes
Regime
Pros
Cons
information on various variables rather (iii) Is too rigid and it allows for
than one to determine the best settings
too much discretion.
for monetary policy.
(iv) Has
the
potential
to
(iv) Easily understood by the public and thus,
increase output instability
transparent. IT has been associated with
along with lowering of
increased transparency and accountability
output growth
of monetary policy.
(v) The exchange rate flexibility
(v) Reduces the likelihood of the central bank
required for success in
of falling into time inconsistency trap since
inflation targeting might
it raises accountability and transparency
cause financial instability,
especially in the context of
(vi) Sustained success in the conduct of
the
emerging
market
monetary policy as measured against a
economies
pre-announced and well-defined inflation
target can be instrumental in building
public support for creating an independent
central bank
Issues Related with Introducing Indirect Monetary Policy Instruments
Advantages of Indirect Monetary Policy Instruments
23.
The following are the main benefits of indirect monetary policy instruments:
a)
Unlike direct controls, they do not encourage disintermediation and the growth of
an informal financial sector, which lowers the share of financial assets that the
monetary authorities control;
b)
Indirect instruments permit much greater flexibility in policy implementation. Small,
frequent changes in instrument settings are feasible, enabling the authorities to
respond rapidly to shocks and to correct policy errors quickly, prompting the need
for major shifts in policy. Such timely responses are difficult with direct instruments,
particularly credit ceilings, since they are often set on an annual or quarterly basis.
Frequent changes in credit limits would also place an undue burden on banks,
since banks typically lack the administrative means to adjust their credit portfolios
abruptly.
c)
Indirect instruments’ reliance on market forces helps to “depoliticise” the
formulation of monetary policy and the allocation of credit.
d)
They can help to deepen financial market. Unconstrained, competitive, deep
financial markets tend to price capital according to its scarcity, in a transparent and
efficient way. Credit tends to flow to those able to pay the highest rates (adjusted
for risk), hence those able to use resources most productively. It therefore,
improves the efficiency of investment, as well as in increase in savings.
12
24.
Inherent Complexities in the Use of Indirect Monetary Policy Instruments
a)
Much of the appeal of direct methods lies in the close and apparently forthright link
they seem to have with policy objectives. Such a simple correspondence does not
hold in the case of indirect instruments, and policy may be more difficult to
implement by indirect methods. Only bank reserves (the monetary base) or, at
most, one short-term interest rate (the overnight rate or money market rate, such
as the three month bill rate) may be controlled in the short run. Therefore, the
central bank needs to define its objectives clearly and know how to set its
instruments to achieve them. Because of lags in the transmission process, the
effects of particular setting cannot be observed immediately.
b)
Some aspects of financial liberalisation that accompany the introduction of indirect
instruments may complicate the conduct of monetary policy. In many cases for
example, interest rate liberalisation, or the ending of credit controls, destabilises
money or credit aggregates for a time, making their control virtually impossible. In
addition, interest rates and exchange rates may become more interdependent.
Finally, the opening of the capital account, drastically curtails the authorities
influence over the real rate of interest, even in the short run.
Criteria for Determining the Instrument mix
25.
As regards the indirect monetary policy instruments, the most important matter is the
criteria for determining the instrument mix. The following are the general criteria to be used:
I.
The extent to which the instrument can control the variable that the monetary authority
wishes to influence, such as the levels of money, credit, and interest rates. To exercise
control, the effects of using the instruments must be predictable. The ability to control is
also enhanced if the instrument is flexible, that is, if it’s monetary effects can be changed
or reversed relatively quickly.
II.
Side effects on resource allocation. Would the use of the instrument interfere with
financial markets and distort the allocation of real resources? For example, credit
controls on each bank may be highly effective in controlling the aggregate amount of
credit, but they can lead to financial disintermediation, slow down market development,
and distort the allocation of resources.
III.
The extent to which the instrument contributes to the overall financial development of the
country and the stability of its financial system. For instance, central bank operations
with securities are not only a means of controlling the amount of liquidity but can also
encourage the development of financial markets, particularly those for short term
government debt instruments.
IV.
Whether the central bank can use the instrument to deal with financial shocks and
stresses on a bank specific basis, for instance by assisting individual banks to adjust to a
temporary outflow of deposits. A discount window can be used to address individual
problems of this type.
26.
In general, central banks make use of several instruments of monetary policy, in light of
the multiplicity of criteria outlined above. This requires them to coordinate how much each
13
instrument will be used and how its use will affect the overall level of liquidity. Reserve money
programming is an indispensable tool in achieving this coordination, since it can be used to
analyze systematically the sources and uses of liquidity.
Pros and Cons of Different Indirect Monetary policy Instruments
Table 3: Pros and Cons of Different Monetary Policy Instruments
Instruments
Advantages
Disadvantages
Reserve
requirements
An increase in reserve
requirements can be
useful
in
one-off
sterilization of excess
liquidity
Rediscount
window
Develops demand for
rediscountable papers.
May also be used in
circumstances where
open
market
operations are limited
due to lack of papers.
Primary market
sales of central
bank
papers
(Open
market
type operations)
Flexible instrument for
short-term
liquidity
management because
issuance is at the
discretion of central
bank, and various
auction/tender formats
can be used to steer
interest
rates.
If
treasury is not willing
to accept sufficient
interest rate flexibility,
central bank papers
preserve operational
autonomy of central
bank.
A
high
requirement
imposes tax on bank
intermediation. This can be
neutralized through reserve
remuneration at market
rates. The tax may result in
a widening of the spread
between
lending
and
deposit rates, which can
lead to disintermediation.
Not convenient for shortterm liquidity management,
as
frequent
changes
disrupt
bank
portfolio
management.
Not very convenient for
precise
base
money
targeting, since access to
window is usually at
initiative of banks. Criteria
for rediscountable paper
and for access to window
have often utilized to
implement selective credit
policy
If central bank bills are
used in parallel with
treasury bills, problem may
occur in the absence of
strong
coordination
between
the
issuing
agents.
14
Experience
and
assessment
Used extremely in
many
developing
countries.
Active
variation for policy
purposes
has
dropped
significantly
in
industrial countries
Used
in
many
countries
as
a
standard instrument
for
monetary
control,
although
access at initiative
of
banks
can
complicate
its
usefulness.
Used
by
many
countries,
particularly
when
there is a need to
separate monetary
policy
objectives
from public debt
management
objectives.
Also
used
when
secondary markets
are
insufficiently
developed to permit
open
market
operations in the
secondary market.
Primary- market
sales
of
government
securities (Open
market
type
operations)
Foreign
Exchange
(FX)
swaps
and
outright
sales
and purchases
Secondarymarket
operations
(outright
purchases and
sales or repo
operations)
-It will be an important
instrument,
if
appropriate
coordination between
treasury and central
bank is achieved. . -Encourage
fiscal
discipline on the part
of the government if
direct central bank
financing
is
discontinued
In case of deep
foreign
exchange
market but inactive
government securities
market, swaps can
substitute for repo
operations
in
government
papers.
FX outright sales and
purchases may be
useful
when
FX
market
is
more
developed than money
market
Can be undertaken on
continuous
basis:
hence
provide
flexibility. Transparent.
Enhance
market
development.
Immediacy
of
response in money
market.
Debt
management
objective can conflict with
monetary management, if
treasury
manipulates
auction to keep funding
costs below market. When
monetary
management
relies on primary issuance,
high frequency of auctions
may hamper secondary
market developments
Used
in
many
countries
when
secondary markets
are
insufficiently
developed
to
conduct
open
market operations
Central bank can suffer
losses if foreign exchange
operations are used in
attempts to preserve an
unsustainable
exchange
rate.
Swaps used on a
regular basis by few
countries
(e.g.
Switzerland)
Require liquid and deep
secondary market, and
central bank must have an
adequate
stock
of
marketable assets.
Used
by
most
countries with liquid
and
deep
secondary markets.
Supporting Actions to Facilitate Effective Use of Indirect Monetary Policy Instruments
Insulate Monetary Policy From deficit Financing
27.
The following are required in order to insulate monetary policy from deficit financing:
I.
Setting strict limits on monetary financing of the government’s fiscal deficit by a central
bank;
II.
A comprehensive programme for public debt management- This programme involve
widening the range of debt instruments and holders; adopting market based selling
techniques; and strengthening secondary market arrangements and coordination with
monetary management.
15
Strengthen and Integrate Money Markets
28.
Because control by the Central bank over the supply of reserve money is the fulcrum of
indirect monetary control, such methods will not be fully effective unless the “market” for shortterm bank liquidity (either an interbank or a money market) can signal and transmit the central
bank’s actions rapidly and transparently to all market participants. Thus, seamless money and
interbank markets are essential to the full use of indirect instruments. There are two aspects to
market development. First measures to improve market infrastructure such as modernizing the
payment and clearing system; , an appropriate legal framework to permit securities trading (
covering such issues as settlement procedures, collateral arrangements, trading rule, and the
regulatory framework for securities markets ) and suitable market instruments and techniques
(such as commercial papers and repos etc). These conditions facilitate interbank transaction
and active liquidity management.
Foster Competition in the banking sector and restructure the banking system
29.
A healthy and competitive banking and financial system is a key element in ensuring that
central bank actions to control the supply of liquidity are fully and rapidly transmitted. If the
commercial banks do not respond to the signals given by the central bank by altering interest
rates or liquidity conditions, indirect instruments will not have the desired effect on monetary and
credit conditions and hence on the economic objectives.
30.
The experience of money countries also indicate that, without appropriate restructuring
to deal with problem loans and problem banks, weaker segments of the banking sector may not
be able to adapt to the newly competitive environment raising the risk of a financial crisis.
Existing weaknesses in bank’s asset positions become increasingly difficult to manage as the
economy becomes liberalized and debtors can no longer accumulate arrears. For example,
banks holding old government paper issued at low rates may face capital losses when interest
rates increases. The imposition of hard budget constraints and the ending of interest rate
subsidies, which frequently accompany financial liberalization and the introduction of indirect
monetary instruments, put pressure on bank’s financial positions.
Adapt supervisory and Regulatory Framework to Market Conditions
31.
In an environment of liberalized interest rates and unrestricted credit allocation, the
ongoing solvency of particular financial institutions hinges on the ability of those institutions to
manage new credit and market risks. Safeguards- in the form of minimum capital standards,
provisioning for doubtful loans, limits on loan concentration, collateral requirements, collateral
valuation standards, and adequate enforcement mechanisms- are needed to foster prudent
behavior by financial institutions. Financial reporting and disclosure standards are needed to
guarantee transparency in the operations of financial institutions and provide a basis for the
public to assess the creditworthiness of particular financial institutions. The too frequent
experience has been that financial liberalization in the absence of such measures –lead to
financial crisis and subsequent reversion to direct methods of monetary control.
Bolster the Technical Capacity of the Central Bank
32.
Regardless of the instruments they use, central banks need to build up their technical
capacity to maintain monetary control in an increasingly sophisticated financial world. Reliance
on indirect instruments requires that the central bank have the capacity to project the demand
and supply of reserves and their effect on broader credit and money aggregates; it also
16
assumes that the central bank has the legal capacity to utilize indirect instruments, which may
require changes in central bank legislation. Thus, the central bank will need a programming
framework and some ideas of the money multiplier relationship to estimate how much reserve
money to add or withdraw to achieve the required effect on broader money and credit
aggregates. This can be particularly difficult during the transition period when several of the key
behavioral relationships tend to become unstable, at least temporarily, thereby, greatly
diminishing the information content of past observations. In those circumstances, central banks
have to adjust their implementation strategies and tactics accordingly.
33.
As part of their programming framework, central banks need to develop a framework for
managing liquidity they provide to the market in order to ensure that the short-run instrument
setting is consistent with the policy objectives. Specifically, such a programme provides the
central bank with indications about the timing and the size of its interventions, which helps in
making indirect instruments of monetary policy most effective.
34.
To be useful, a reserve money programming requires timely and accurate data on the
central bank balance sheet and financial sector development.
Key Global Challenges in the design and Implementation of Monetary Policy
35.
Monetary authorities still face multiple challenges in the design and implementation of
monetary policy. These challenges may be institutional or technical and could emanate from
external developments and/or macroeconomic shocks. The following are the key challenges:
a)
Lack of independence by Central Banks. In some countries, it is a statutory requirement
for the central bank to be under the scope of the Ministry of Finance. In other countries,
political forces determine the actions of the central bank, thus affecting the central
bank’s ability to maintain legitimacy and objectivity.
b)
Central banks may be constrained by conflicting monetary policy objectives. Policy
makers are often faced with multiple objectives that are equally desirable. This creates
challenges in assigning a single policy instrument to an objective. Furthermore, while
some objectives are consistent with each other, others are not, for example maintaining
the exchange rate at a particular level can often limit a central bank in using policy
instruments such as interest rates.
c)
The lack of fiscal discipline. This is often characterized by high levels of government
budget deficits and public debts. The central bank has to, therefore, focus its monetary
policy towards meeting government spending objectives rather than price stability.
d)
Weak transmission mechanisms mainly caused by under developed financial markets
often obstruct monetary policy effectiveness. This may be due to a shaky banking
system that may discourage policy makers from the use of aggressive policy rates for
the fear of the effects of these changes to balance sheets of already fragile banks.
e)
Lack of market integration within developing countries often results into asymmetrical
response to monetary policy. Consequently, the delays in the effects of monetary policy
on economic activity are relatively longer and more variable. The absence of deep and
17
liquid markets also means that there is inadequate feedback about the effect of the
policy actions on the market.
f)
Heavily aid dependent countries also suffer from distortions caused by aid flows. These
flows are often volatile and can greatly disorganize policy makers in their efforts to
implement monetary policy. Moreover, external shocks like the worldwide food and
energy prices experienced in 2007 and 2008 may distort inflationary expectations and
therefore make it hard for policy makers to formulate pertinent strategies to respond to
these shocks.
g)
Central banks also face technical challenges in implementing monetary policy especially
inflation targeting. The central bank needs the technical capacity to model the economy,
understand the transmission mechanism and forecast inflation and output.
h)
Central bankers have to make decisions in a world of pervasive uncertainty. The
uncertainties are related to the state of the economy, the structure of the economy, and
the interaction between private sector and the policy makers. The following are the
nature of the uncertainties:
i)
The uncertainty related with the state of the economy arises from the imperfectness
of information used for analysis; and difficulty in identifying the nature of the shocks
that are driving observed economic developments. That is whether shocks, originate
from domestic or foreign sources, and are transitory or long lasting.
ii)
The uncertainties related with the structure of the economy result from imperfect
knowledge by central banks on suitable descriptions of the structural relationships in
the economy. They are not sure which models provide suitable descriptions of the
structural relationships in the economy. As a result, central banks cannot afford to
rely on one single model of the economy, but need to have a number of alternative
modeling tools available. For example, there is a widespread consensus that inflation
is, as indicated by the quantitative theory of money, a monetary phenomenon in the
long run. At the same time, there is a multiplicity of different approaches, of modeling
the inflation process at short and medium-term horizons. Even if there were a
consensus on a suitable model of the economy, considerable uncertainty would
remain regarding the strength of the structural relationships, i.e. the value of
parameters, within that particular model. Inevitably, available parameter estimates
are affected by data imperfections and by the particular econometric techniques that
are employed for estimation. An even more fundamental problem is that parameters
may vary over time as a result of structural change in the economy. Uncertainty
about parameters confronts all central banks.
iii)
The uncertainty related with the interaction of the private sector and policy is related
to the role of expectations. The central bank often wonders about the reaction of
economic agents and financial markets to its own policy decisions and
announcements. Conversely, economic agents may be unsure about the precise
motivations and actions of central banks and other economic agents. This is always
the case, even if market developments are fairly close to what would be expected
based on fundamentals. However, the degree of this kind of uncertainty may in some
cases become especially pervasive. This appears when some of the uncertainties
mentioned above are amplified by deeper or more widely spread doubts on the side
18
of market participants about the stability of economic relationships, thus leading to
what some call "fundamental uncertainty". Such developments are relatively limited
in developed countries as their central banks usually prevent their appearance
through the very success of their policies. However, their potential occurrence needs
to be taken into account by central banks in order to avoid them.
36.
The following are key strategies many countries used to address the above challenges:
a)
Fiscal and monetary policies should be complementary and should ensure
consistency with the overall goal for an economy.
b)
Getting rid of everything used to undermine the effectiveness of monetary policy,
which include political interference, fiscal dominance, and poor legal environments.
This can be achieved by giving independence to a Central Bank and giving the
Central Bank a clear mandate and appropriate instruments for achieving a
sustainable reduction of inflation.
c)
When setting monetary policy and in order to ensure consistency with the overall
goal for an economy; central banks should look beyond just inflation by taking into
account other variables that many times are spelled out in their charter. These
include stability of financial markets and institutions, balance of payments
equilibrium, the level and quality of information data and the communication
facilities in place should ensure consistency with the overall goal for an economy.
d)
Monetary policy can effectively maintain price stability but it must be accompanied
by structural reforms that will create the enabling environment for accelerated
growth in the long run. Therefore, notwithstanding the central bank’s monetary
policy stance to preserve price stability and create enabling environment to foster
growth, structure reform to ease binding constraints in the economy must be
implemented to make the economy competitive.
e)
Take appropriate measures to reduce uncertainties of Central Banks as related to
the state of the economy, the structure of the economy, and the interaction
between private sector and the policy makers
Analysis of Monetary Policy Frameworks in Selected African Countries
37.
There have been several significant changes since the 1990s in the design and conduct
of monetary policy around the world, including in African countries. Two main examples of these
changes are: first, the movement by a number of countries, many in Africa, from fixed exchange
rate regimes to more flexibility, which has allowed for greater monetary independence. Second,
the adoption of inflation targeting regimes as a framework for conducting monetary policy in
several industrial countries, as well as in about 19 emerging economies and developing
countries to date (including three African countries). Table 4 below shows monetary policy
frameworks in Sub-Saharan African Countries (SSA).
Table 4: Monetary Policy Frameworks in SSA Countries
Type of Framework
Exchange
Number of Countries
Rate 23
19
Pegs
Inflation Targeting
RSA, Mauritius, Ghana, Uganda (IT light), Kenya (hybrid), Rwanda
(soon)
Monetary targeting
18
Source: Kasekende et al. (2010)
38.
Many African countries have been using money supply as a nominal anchor under the
monetary policy framework but a breakdown in the relationship between money and inflation,
which lead to challenges in the ability to forecast reserve money, has led some countries to
abandon the framework.
39.
Exchange rate targeting uses the exchange rate as a nominal anchor and comes in two
forms: soft and hard pegs. More than half of the countries in SSA anchor their monetary policy
on an exchange rate peg. 14 of these countries are members of the West African and Central
African CFA Zone Monetary Union. Botswana is pursuing a crawling peg where the Botswana
Pula is pegged to a basket of currencies (Rand, Euro, and USD), while Lesotho, Namibia and
Swaziland are using hard pegs to the South African Rand under the Common Monetary area
(CMA). These countries have registered single digit inflation rates with the exception of the
global financial crisis era. Furthermore, inflation has been less volatile in these countries.
The limitation of exchange rate targeting is the loss of independent monetary policy and thus the
inability to protect the target countries from shocks transmitted from the anchor country.
40.
Under inflation, targeting (IT) the anchor is the expected rate of price increase and not
the price level by committing to a given level of inflation. As of now, only three African countries
have successfully adopted this regime: South Africa, Ghana, and Mauritius. Some review
studies made on their performance indicate that they are making good progress. The transition
process to IT is also underway or exsits in a number of other African countries (Uganda,
Botswana, and Namibia). Kenya is currently employing a hybrid monetary policy framework of
both IT and monetary target.
Performances of the Existing Monetary Policy Regimes in Selected COMESA Member
Countries
41.
The anecdotal evidence of monetary policy regimes in some selected COMESA
countries are summarized in Table 5 in the next page. The table shows that most of the
COMESA member countries shifted from direct to indirect monetary policy control as part of
financial sector liberalization process undertaken under the structural adjustment programmes.
It indicates that there is consensus that direct controls on interest rates and credit led to the
misallocation of resources and inefficiency in financial intermediation with adverse effects of
savings mobilization, investment and economic growth. It also indicates that most COMESA
central banks currently use the quantity theory of money framework in projecting money
demand. This approach is based on studies that support existence of stable money demand
functions for these countries. Most central banks have similar monetary policy instruments,
namely, open market operations, reserve requirement and standing facilities. In terms of
monetary policy signaling, Treasury bill rates have signaling effects on the monetary policy
stance but this has been compromised by the fact that it is highly influenced by fiscal policy.
Table 5 below also describes the characteristics of various indirect instruments of monetary
policy and summarizes their advantages and disadvantages.
20
42.
The main achievements under the current monetary targeting framework are, among
others, that most central banks have harmonized their monetary aggregates data. They have
also achieved relatively lower inflation rates than in earlier periods. In addition, a number of
COMESA central banks have developed monetary policy rates with signaling effects on the
monetary policy stance and shares information relevant to the transition to inflation targeting
framework.
43.
The table indicates that most COMESA countries have faced challenges that have
raised concerns about the appropriateness of the current monetary targeting framework. These
concerns arise from instabilities in the money multiplier; interest rate volatility; problems in
forecasting liquidity; choice of reserve aggregates for targeting as well as limited and inflexible
monetary policy instruments. Efforts are ongoing in most central banks to carry out studies on
monetary policy transmission mechanism, strengthening real sector databases, capacity
building in formulating simple macroeconomic, forecasting and simulation models as a basis for
improving the current framework and for moving to inflation targeting.
21
Table 5: Performance and challenges of the existing monetary policy regimes in selected
COMESA countries
Country
Uganda
Monetary
Policy
Framework
 Has
transitioned
to an inflation
targeting lite
monetary
policy
framework
since July
2011
 The primary
policy
objective of
monetary
policy
remains
unchanged:
the control of
core inflation
over a
medium term
horizon.
 Monetary
policy
management
is hinged on
using the set
interest rate
as the
operating
target of
monetary
policy.
Monetary
Performance
Challenges
Policy
Instruments
 Prior
to  Since
the  While inflation expectations
markets
adoption of
have
been
anchored
liberalization
the inflation
through the reserve money
s,
direct
targeting lite
programme, instability of the
monetary
program,
money multiplier and to
policy
inflation has
some extent velocity has
control was
been
raised concerns over the
applied. This
brought
appropriateness
of
the
involves
under
current
approach
to
interest rate
control.
monetary policy.
and
credit  Inflation
 Problems in forecasting
controls
declined
autonomous
factors
 A shift to
from doubleaffecting base money and
indirect
digit levels
the instability of money
monetary
of 66% in
multiplier have undermined
policy
June 1992
effectiveness of the reserve
control was
to
singlemonetary program
part
of
digit levels  Underdeveloped
financial
financial
for most of
sector, characterized by low
sector
the 1990s to
degree of monetization of
liberalization
June 2008.
the economy
process.
It has since  Management of donor aid
risen to 10%
 Open
flows and implications for
- 15% range
market
conduct of monetary policy
but
is  Interest rate volatility
operations
forcasted to  Weak
through
interest
rate
return
to
treasury bills
sensitivity.
single digets
and
in 2013
repurchase
agreements
 The
are
the
impressive
principle
inflation
instrument
outturn
is
for
largely
a
managing
result of the
day-to-day
continued
liquidity.
pursuance
of prudent
 Other
monetary
instruments
and
fiscal
include:
policies.
Bank rate,
cash
 Fiscal
reserve
restraint, in
requirement
conjunction
22
Table 5: Performance and challenges of the existing monetary policy regimes in selected
COMESA countries
Country
Monetary
Policy
Framework
Zambia


IMF’s
financial
programmi
ng form the
core of the
monetary
targeting
framework
Broad
money
supply and
reserve
money
consistent
with
inflation
target and
economic
growth
objective.
Monetary
Performance
Challenges
Policy
Instruments
s
and
with
close
rediscount
corate.
ordination
between the
monetary
and
fiscal
authorities
contributed
significantly
to bringing
down
inflationary
expectations
.
 Prior
to  Since
 Weak and underdeveloped
1992,
implementati
financial
system
that
Zambia
on
of
curtailed the effectiveness of
relied
on
monetary
the monetary policy.
direct
targeting
 Money
market
instruments
framework
imperfections
evidenced
of monetary
and use of
through interest rate volatility
policy such
indirect
and the weakness in the
as
fixed
monetary
fiscal policy.
interest
policy
 Impact of external shocks
rates
and
instruments,
such
as
international
credit
inflation has
fluctuation of commodity and
allocations,
fallen
oil prices.
core liquid
remarkably
assets,
from 3 digits
statutory
in
early
reserve
1990s
to
requirement
double
and
fixed
digets in the
exchange
from 2004rate regime.
2009
and
single since
 Indirect
2010.
monetary
policy
 Exchange
instruments
rate
has
employed
been
currently are
relatively
the
open
stable
market
operations
23
Table 5: Performance and challenges of the existing monetary policy regimes in selected
COMESA countries
Country
Monetary
Policy
Framework
Kenya
 Employs a
hybrid
monetary
policy
framework of
both inflation
targetting
and
monetary
targetsto
achieve
inflation
objective.




 The
framework
has remained
fairly
the
same
with
the
bank
continuously
refined
monetary
policy
operations
and
procedures
to enhance
efficiency
and
effectiveness
Monetary
Performance
Challenges
Policy
Instruments
(Secured
Loans, Term
Deposits &
Treasury bill
auctions),
Bank Rate,
Rediscount
facility, and
Core Liquid
Asset Ratio.
 Prior
to  Monetary
 An unstable relationship
financial
targeting
between money and inflation
market
framework
due to financial deregulation,
liberalization
has served
and an increasingly unstable
,
direct
the country
money multiplier and to
monetary
well
with
some extent velocity are
policy
refinement of
making it difficult to derive a
instruments
operations
credible path for money
were used.
and
supply.
These were
procedures
 Challenges of forecasting
in form of
to enhance
liquidity within a short-time
interest and
effectiveness
period constrained effective
credit
. The surge
implementation of Open
controls.
in inflation in
Market Operations. This
early 1990s
 Indirect
mostly
manifested
in
to
about
monetary
excessive
fluctuation
of
70%
(the
policy
short-term interest rates.
time
of
first
instruments
 Challenges
due
to
multiparty
currently
increasingly
globalized
elections in
employed
World.
1992) led to
include open
amendment
market
of the CBK
operations,
Act in 1996
bank
rate,
to give CBK
cash
ratio
more
requirement
autonomy to
s
and
manage
rediscount
monetary
facility.
policy.
 The inflation
has
been
maintained
at
24
Table 5: Performance and challenges of the existing monetary policy regimes in selected
COMESA countries
Country
Monetary
Monetary
Policy
Policy
Framework
Instruments
its objectives
in a changing
financial and
economic
environment
 In formulation
monetary
program for a
specific
period,
the
bank
start
with
estimating
the
money
demand
consistent
with
the
target rate of
inflation and
GDP growth.
This form the
basis
for
setting
desired path
for monetary
growth
to
which actual
money
supply had to
conform
during policy
implementati
on stage.
 However,
with the time
lag
in
obtaining
information
needed
for
effective
control
of
broad
monetary
aggregates,
Performance
satisfactory
level
supported by
fiscal policy.
The inflation
rate
recorded
single digit in
most cases
since 1995
and
it
averaged
9.4%
from
2004-2008.
It
however
surge
to
15.1%
in
2008 owing
to rise in
food prices
and
international
oil
prices.
Inflation rate
for 2013 is
estimated to
be 5.2%. .
25
Challenges
Table 5: Performance and challenges of the existing monetary policy regimes in selected
COMESA countries
Country
Malawi
Monetary
Monetary
Performance
Challenges
Policy
Policy
Framework
Instruments
the
CBK
formulates its
monetary
policy
implementati
on strategy
on the basis
of
reserve
money-more
readily
available as
liability of the
central bank.
The reserve
money
program
design
is
consistent
with desired
money
supply
expansion.
 Monetary
 Initially used  Since
 Weak and underdeveloped
targeting
direct
adoption of
financial
system
that
framework. In
monetary
the monetary
curtailed the effectiveness of
the pursuit of
policy
targeting
the monetary policy.
price stability,
instruments
framework
 Interest rate volatility
the
bank
such
as
the pace of  Thin and shallow markets
monitoring
interest
inflation
 Limited
number
of
growth
in
rates
and
decelerated
participants
reserve
credit
from a range
o Only banks are the major
monetary
controls,
of
29.6participants – this lowers
aggregate.
strict
83.3%
the competitiveness of
To influence
controls on
between
price setting
growth
in
foreign
1994
and
o Policy actions lead to
monetary
exchange
2000) to an
disproportionate
price
stock
the
and capital
average of
movements
Central Bank
flows.
12.5%
 Limited instruments- Only Tincreases or  After
between
bills, Tbonds, Forex and
decreases
2004- 2008.
liberalization
Repos
the amount
shifted
to
 No secondary markets for
of
reserve
indirect
securities-Once
acquired,
money
by
monetary
agents tend to hold financial
managing
policy
assets to maturity. This
26
Table 5: Performance and challenges of the existing monetary policy regimes in selected
COMESA countries
Country
Swaziland
Monetary
Monetary
Performance
Challenges
Policy
Policy
Framework
Instruments
both
instruments
causes makes the market
domestic and
that include
insensitive to interest rate
foreign
open market
movements
sources
of
operations,
reserve
liquidity
money.
reserve
requirement
 The
bank
s,
daily
repurchase
management
and discount
of monetary
window
movements
facility.
involves
estimates of
banking
system
liquidity
situations.
 No
 The tools at  Single digit  The CMA limits the country’s
independent
the disposal
annual
to formulate and implement
monetary
for the bank
inflation rate
monetary policy or respond
policy
include the
recorded
to external shocks
discount
since 1996  Rand circulations in the
 Currency is
interest rate,
averaging
pegged
to
economy
render
the
reserve
6.46% from
the
South
measurement of money
requirement
2004-2012.
African Rand
supply to be understated.
s,
and
open

Just
like
This is compounded by
 Monetary
market
most
pegging rand to the local
policy
operations.
countries,
currency.
formulation
The
Bank
the inflation  Free access to South Africa
influenced
however
rate surge in
largely
by
money and capital markets
utilizes
2008
to
membership
limits
the
CBS
from
interest
double
digit
to Common
controlling money supply.
rates
that
due to rise in  Small and shallow financial
Monetary
has proved
food and oil
Area (CMA).
market
effective to
prices.
The countries
curtail
facilitate
inflation
smooth
arising from
implementati
the demand
on of CMA
side.
agreements
free
through CMA  With
flow
of
Governors
capital
meeting
under
the
27
Table 5: Performance and challenges of the existing monetary policy regimes in selected
COMESA countries
Country
Monetary
Policy
Framework
Seychelle
s
 Prior
to
enactment of
the Central
Bank
of
Seychelles
Act of 2004
economic
management
relied heavily
on
fiscal
policy
with
monetary
policy
relegated to
accommodati
ng role.
 Since
November
2008,
the
Monetary
Policy
Framework is
based
on
monetary
targeting
rather
than
the traditional
Monetary
Performance
Challenges
Policy
Instruments
CMA
and
unitary fixed
exchange
rate to rand
(no
exchange
rate
risk)
implies
limited
scope
for
the
Swaziland
interest rate
to
deviate
substantially
from South
Africa’s.
 Open
 Prudent and  Monetary
policy
market
wellimplementations need to
operations balanced
strengthen the influence of
Treasury bill
monetary
interest rates on economic
auction,
and
fiscal
developments.
deposit
stances
 The Bank will place more
auction
have
emphasis on steering shortarrangement
reduced
term interest rates with the
s
and
inflation
to
development
of
the
foreign
low
single
interbank
and
money
exchange
digit
since
markets.
auction
1999.
 Minimum
 Weak
coordination
Reserve
between
Fiscal
and
Requiremen
Monetary
t (MRR)
 Unpredictability
of
 Local asset
government
Ratio- This
budgetary flows
tool requires
 Large
and
commercial
Unpredictable
banks
to
expenditure
floats.
invest
a
This makes it difficult
specific
to match monetary
percentage
policy actions with
of their local
actual flows, and
currency
hence
reduces
deposit
effectiveness of the
28
Table 5: Performance and challenges of the existing monetary policy regimes in selected
COMESA countries
Country
Monetary
Monetary
Performance
Policy
Policy
Framework
Instruments
exchange
liabilities in
rate
government
targeting.
securities
and
other
 This
claims
on
transition
government
was
to
and
has
support
a
been
an
liberalized
important
foreign
vehicle for
exchange
funding
market and
government
floating
deficits
exchange
since
its
rate regime
inception in
as part of
1986.
IMF Lending
supported
economic
facility: The
reform
Standing
program
Credit
adopted by
Facility
the
(SCF) is an
authorities in
overnight
November
collateralize
2008.
d
loan
facility that
 In monetary
provides
targeting
funds to the
framework,
commercial
the
final
banks,
to
target - price
cover
stability - is to
temporary
be achieved
end-of-day
by
shortfalls
influencing
that
can
changes
in
arise in the
the
total
daily
amount
of
settlement
liquidity in the
of
economy,
payments. T
with reserve
he
money being
Emergency
the
Lending
intermediate
facility (ELF)
operating
29
Challenges


actions.
Weak monetary policy
transmission
Banks are insensitive to
interest rate movements in
the primary market due to:
 Structural
impediments
impair
monetary
policy transmission
 Inherent risk in the
economy,
 Weaknesses in the
legal framework,
 Low
market
competition
Table 5: Performance and challenges of the existing monetary policy regimes in selected
COMESA countries
Country
Egypt
Monetary
Monetary
Performance
Policy
Policy
Framework
Instruments
target
of
is
an
monetary
emergency
policy
liquidity
support
 Quarterly
facility
monetary
primarily to
targets
are
prevent
set.
severe and
 Interventions
persistent
for managing
short-term
bank's
liquidity
liquidity are
problems to
guided
by
lead
to
liquidity
insolvency
monitoring
and to avoid
framework
bank runs.
maintained
by
the
Bank. This
framework
identifies the
factors that
influence
bank liquidity
and is used
to
make
forecasts on
future
liquidity
flows.
 Monetary
 Direct
 Timely
targetinginstruments
monetary
intermediate
such
as
policy
target
quantitative
responses
involved
and
by
the
control
of
administrativ
Central Bank
annual
e
manage to
growth rate in
determinatio
contain
domestic
n of interest
inflation
liquidity
rates using
expectation
measured in
interest rate
particularly
terms
of
and
credit
emanating
broad money
ceiling were
from
supply.
abolished
demand
from
1992.
pressures.
 The changes
30
Challenges



Weak monetary policy
transmission
Banks are insensitive to
interest rate movements in
the primary market due to:
o Structural impediments
impair monetary policy
transmission
o Inherent risk in the
economy, and
o Weaknesses in the
legal framework
Low market competition
Table 5: Performance and challenges of the existing monetary policy regimes in selected
COMESA countries
Country
Burundi
Monetary
Monetary
Performance
Challenges
Policy
Policy
Framework
Instruments
involved
However,
 Mostly relied
modification
heightened
on indirect
of operational
inflation
market
and
expectation
based
intermediate
mainly
in
instruments
targets
as
2008
was
such
as
well
as
driven
by
required
choice of the
supply
reserve
monetary
shocks such
ratio,
policy
as
reserve
instruments.
international
money and
fuel
price
 Principal
open market
hike.
monetary
operationspolicy
discount
remained
rate
and
focused on
interest rate
price stability
and
stabilization
of exchange
rate.
 The
operational
target initially
involved
nominal
interest rate
management
and
controlling
excess bank
reserves but
in 2005 was
replaced by
overnight
interest rate
on interbank
transactions.
 Monetary
 Prior
to  Remarkable  Small and shallow financial
aggregate
1986, direct
success
market
targets. The
monetary
recorded to
country
policy
return
of
implementing
instruments
inflation
to
IMF’s
used such
average of
31
Table 5: Performance and challenges of the existing monetary policy regimes in selected
COMESA countries
Country
Monetary
Policy
Framework
Poverty
Reduction
Growth
Facility
Program.
Zimbabwe
 Official
dollarization
Monetary
Performance
Challenges
Policy
Instruments
as
credit
10.9% from
ceiling and
2004-2012.
interest
It rose to
rates
26% in 2008
control.
due mainly
to surge in
 Indirect
food and oil
instruments
prices.
adopted
after 1986
through the
structural
adjustment
programs.
The
instruments
at
the
disposal of
the central
bank
include;
refinance
policy,
auction
of
treasury
certificates
and reserve
requirement
s.
 In
the  Good
 High fiscal deficits absorbed
1980s, the
progress
large portion of domestic
instruments
initially made
savings
were direct
before
 Undeveloped
financial
control
of
political
system
with
lack
of
interest rate,
instability set
competition in the banking
credit
in and which
system
ceilings, use
greatly
of
reserve
negatively
bank
bills
affected the
and
independenc
prescribed
e
of
liquid assets
monetary
ratio
policy
 The
instruments
32
Table 5: Performance and challenges of the existing monetary policy regimes in selected
COMESA countries
Country
Monetary
Policy
Framework
Monetary
Performance
Policy
Instruments
at the Bank
disposal
were Bank
rate, open
market
operations
and reserve
requirement
s
Challenges
Proposal for Appropriate Monetary Policy Regime for COMESA Member countries
44.
As the shortcomings of monetary targeting framework have become more apparent,
many of the COMESA central banks have to start the journey towards formal inflation targeting
frameworks. A successful implementation of inflation targeting, as an alternative to monetary
policy framework, would require the following conditions to be in place: a strong fiscal position
and entrenched macroeconomic stability; a well-developed financial system; Central bank policy
and instruments independence and a mandate to achieve price stability; reasonably well
understood channels between policy instruments and inflation; a sound methodology for
inflation forecasting; and transparent policies to build accountability and credibility.
45.
Given the above factors, the COMESA region requires more time to switch to a regime
of inflation targeting. Therefore, monetary targeting seems to provide a more realistic and
pragmatic monetary policy framework in COMESA countries as the preconditions for
implementation of the inflation targeting framework are put in place within each country in
COMESA. The following recommendations are, therefore, made to simultaneous keep refining
the current monetary targeting framework in addition to putting in place the preconditions for
inflation targeting in the future:
Implementing indirect instruments of monetary
46.
The benefits of introducing indirect monetary policy instruments are the following:
a)
Leads to efficient financial intermediation;
b)
Provide effective monetary control, especially in circumstances where direct
instruments have been largely circumvented. This is particularly likely as new
financial instruments develop and the opening of the capital account provides a
wider range of financial alternatives. In such a setting, the shift to indirect
instruments become a matter of necessity;
33
c)
Permit the authorities to choose from a larger set of target than is possible with
direct instruments. This is especially important when the relationship between
particular aggregates such as credit variable, and the final objectives of the
authorities, such as price stability, has been weakened or has become hard to
establish. Often this is brought about by economic reform or financial innovation.
Undertake key concomitant reforms to minimize difficulties of implementing
monetary policy instruments.
47.
indirect
These include the following:
a)
Monetary Policy needs to be insulated from the pressure of financing the
government’s fiscal deficit. The authorities must curtail monetary financing of the
fiscal deficit, ensure that the government accepts market rates of interest on its
debt, and refrain from pressuring the central bank to keep market interest rates
low. Enhancing Central Bank Independence can help to achieve these goals.
Limits on Central bank credit to the government must be supported by a
comprehensive programme to develop public debt management and government
securities market.
b)
Weak and segmented money and interbank markets need to be strengthened. As
liquidity management by the central bank provides the fulcrum of indirect methods
of monetary control, indirect instruments cannot work well unless the interbank
and short-term money markets can transmit the central bank’s actions rapidly and
transparently. The Central Bank must play an active role in the development of the
market infrastructure, including the payments and settlement system, the legal
and regulatory framework of the markets, and the introduction of suitable market
instruments and techniques. At the same time, the central bank needs to stimulate
trading in these markets. Introducing at an early stage some market-based
indirect instruments that can be transacted at market interest rates can be the
catalyst in developing the money and financial markets needed before full reliance
on indirect instruments is possible.
c)
The banking system often needs to be restructured to create healthy banks and
foster competition. Generally, financial restructuring needs to deal with nonperforming loans and problem banks and with strengthening the managerial
capacity of weaker banks, which may be poorly equipped to adapt to the newly
competitive environment.
d)
The supervisory and regulatory framework needs to be reinforced. All too often,
experience has been that, in the absence of such measures, financial
liberalization leads to financial crisis. Thus, safeguards- in the form of minimum
capital standards, standards for provisioning for doubtful loans, limits on loan
concentration, collateral requirements and collateral valuation standards, and
adequate enforcement mechanisms are needed to encourage prudent behavior.
Financial reporting and disclosure standards are also needed to improve
transparency, so that the market can play its role in ensuring financial discipline.
34
e)
The technical capacity of the central bank needs to be strengthened. Reliance on
indirect instruments requires that the central bank develop a forecasting
framework for short-term reserve money in order to project the demand and
supply of currency and bank reserves and their effect on broader credit and
monetary aggregates. That framework requires timely and accurate data-including
warning indicators –on financial sector development as well as on the central
bank’s balance sheet and must be based on a quantification of key monetary
relationships. There must also be a clear understanding of the monetary policy
transmission mechanism. The Banks should therefore be fully engaged in building
capacity through the training of staff particularly in macroeconomic modelling and
forecasting. These can be achieved through technical assistance from the
International Monetary Fund (IMF) and other Central Banks such as the Bank of
England. A comprehensive research programme in central banks is also required.
Careful sequencing based on country specific circumstances of the path for introduction
of indirect monetary policy instruments.
48.
This should follow the following stages:
a) The first stage normally requires the use of both reserve requirements to absorb
liquidity and a credit facility- such as a credit auction - to provide for the growth of
domestic credit. An overdraft or Lombard facility as a penal interest rate is also
needed. Liberalization of interest rate must begin at this stage.
b) In the second stage, the authorities should introduce auctions of short-term
government or central bank securities. This not only assist the development of
financial markets but also gives the authorities more flexibility in managing monetary
operations and allows for a reduction in reserve requirements. At this stage, the
authorities operate a mix of market-based instruments to foster both monetary
control and market developments.
c) In the third stage, the central bank should accelerate the development of institutions
and financial market infrastructure and begin to rely on full-fledged open market
operations. Total reliance on such operations is not possible until the secondary
market is working well.
Develop a communication strategy that enhances transparency of monetary policy.
49.
The central banks through their respective Monetary Policy Committees should develop
effective communication strategies to ensure that the public understands what they do.
Transparency of monetary policy can be enhanced through frequent dissemination of
information to the public. In addition to the press conference given by the Governor after every
meeting of the Monetary Policy Committee and the release of the Monetary Policy Statement a
week after each meeting, each central bank should have a publication of bi-annual inflation
reports that provides an analysis of inflation developments as well as the assessment
underpinning monetary policy and outlook for inflation. This will enhance the public’s
understanding of the policies being applied to achieve the Bank’s primary objective of monetary
policy. Central banks in COMESA should also start carrying out Inflation Expectation Survey, as
35
is the case by Reserve Bank of South Africa given that inflation expectations are a key input into
the monetary policy making processes.
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37
Annex I: Monetary Policy Framework
Exchan
Monetary Policy Framework
ge rate Exchange rate anchor
arrange
ment
(Numbe
r
of
countrie U.S. dollar
Euro
Comp
s)
osite
(66 Countries)
Exchan
ge
arrange
ment
with no
separat
e legal
tender
(10)
Ecuad
or,
El
Salvad
or,
Marsh
all
Islands
,
Fed.
States
of
Micron
esia,
Currenc Antigu
y board a and
arrange Barbud
ment
a2
(13)
Djibout
i
Other
convent
Domini
ca2
Grena
da2
Hong
Kong
SAR
St.
Kitts
and
Nevis2
Angola
Palau
Panam
a
(27
Countri
es)
Monten
egro
San
Marino
(15
Count
ries)
Other
(7
Countri
es)
Kiribati
Monet
ary
aggreg
ate
target
(22
Countri
es)
TimorLeste
St.
Lucia2
St.
Vincent
and the
Grenadi
nes2
Bosnia
and
Herzeg
ovina
Bulgari
a
Brunei
Daruss
alam
Estonia
3
Lithuan
ia3
Seychel
les
Benin4
Fiji
Bhutan
38
Argenti
na
Inflation
targeting
framework
Other
1
(44 Countries)
(11
Countr
ies)
ional
fixed pe
g
arrange
ment
(68)
Argenti
na
Aruba
Baham
as,
The
Bahrai
n
Bangla
desh
Barbad
os
Belaru
s
Belize
Eritrea
Guyan
a
Hondu
ras
Sierra
Leone
Solomo
n
Islands
Sri
Lanka
Burkina Kuwai
Faso4
t
Camer Libya
oon5
Lesoth
o
Namibi
a
Malawi
Cape
Verde
Moroc
co
Nepal
Sierra
Leone
Surina
me
Central
African
Rep. 5
Swazil
and
Tajikista
n
Trinidad
and
Tobago
Turkme
nistan
Chad5
Russi
an
Feder
ation
Samo
a
Tunisi
a
United
Arab
Emirate
s
Venezu
ela,
Rep.
Bolivari
ana de
Vietna
m
Yemen,
Rep. of
Comor
os
Congo,
Rep.
of5
Côte
d'Ivoire
4
Croatia
Denma
rk3
Equato
rial
Guinea
5
Jordan
Kazak
hstan
Leban
on
Malawi
Maldiv
es
Mongo
lia
Zimbab
we
Gabon
5
Guinea
Bissau4
Latvia3
Maced
onia,
FYR
Mali4
Niger4
39
Rwand
a
Netherl
ands
Antilles
Oman
Seneg
al4
Togo4
Qatar
Rwand
a
Saudi
Arabia
Pegged
exchang
e
rate
within
horizont
al bands
(3)
Crawlin Bolivia
g
peg
(8)
China
Ethiopi
a
Iraq
Nicara
gua
Uzbeki
stan
Crawlin Costa
g band Rica
(2)
Manage Cambo
d
dia
floating
with no Kyrgyz
preRep.
determi Lao
ned
P.D.R.
path for Liberia
the
exchang Maurit
e
ania
rate (44) Mauriti
us
Myan
mar
Ukrain
e
Slovak
Rep.3
Syria.
Tonga
Botsw
ana
Iran,
I.R.
of.
Azerb
aijan
Algeri
a
Singa
pore
Vanua
tu
Afghani Armen
stan,
ia6
I.R. of
Burundi Colom
bia
Gambi Ghan
a, The
a
Georgi Guate
a
mala
Guinea Indon
esia
Haiti
Peru
Jamaic
a
Kenya
Roma
nia
Serbia
6
40
Domini
can
Rep.
Egypt
India
Malay
sia
Pakist
an
Parag
uay
Madag
ascar
Thaila
nd
Moldov
a
Mozam
bique
Urugu
ay
Nigeria
Papua
New
Guinea
São
Tomé
and
Príncip
e
Sudan
Tanzan
ia
Ugand
a
Zambia
Indepen
dently
floating
(40)
Albani
a
Luxemb
ourg7
Austra
lia
Austri
a7
Belgiu
m7
Malta7
Mexico
Netherl
ands7
Brazil
New
Zealan
d
Canad Norway
a
Chile
Philippi
nes
41
Cypru
s7
Czech
Rep.
Poland
Finlan
d7
Franc
e7
Sloveni
a7
South
Africa
Portuga
l7
Congo
, Dem.
Rep.
of
Japan
Somali
a8
Switze
rland
United
States
Germ
any7
Spain7
Greec
e7
Hunga
ry
Icelan
d
Swede
n
Turkey
United
Kingdo
m
Irelan
d7
Israel
Italy7
Korea,
Rep.
of
Source: IMF (2009)
1/ Includes countries that have no explicitly stated nominal anchor, but rather monitor various
indicators in conducting monetary policy
2/ The member participates in the Eastern Caribbean Currency Union
3/ The member participates in the ERM II
4/ The member participates in the West African Economic and Monetary Union
5/ The member participates in the Central African Economic and Monetary Community
6/ The central bank has taken preliminary step toward inflation targeting and is preparing for the
transition to full-fledged inflation targeting
7/ The member participates in the European Economic and Monetary Union
8/ As of end-December 1989
42