Download State-owned Enterprises (SOEs)

Sound Monetary Framework and
Government Bond Market
November 1, 2007
Bali, Indonesia
Noritaka Akamatsu
Regional Advisor for Capital Markets
The World Bank
Issues

Many economies have adopted different monetary
frameworks with different targets and instruments.
However, the framework needs to be practical and
transparent.
Q. What is:
– a sound monetary framework,
– the best practice of monetary operation under the
framework,
– a sound monetary operation under excess liquidity
condition, and
– the importance of government securities market in
monetary operation?
Outlines


Framework for monetary operations.
Seasonality in the banking system liquidity and
factors affecting it.

Bank liquidity projections and M-policy transparency

Choice of M-policy instruments

Government securities repos

Operations
Framework for monetary
operations – 1

Quantity theory of money
– MV = Py, thus ln M = ln P + ln y, assuming ln V = 0
– Money supply should grow at the rate equal to the sum of
the rate of inflation and that of real economic growth.

Central Bank needs to provide liquidity to allow the
economy to grow and the banking system to function
properly.
– stabilize the bank liquidity and money market interest rate.

Central Bank should target at what it can control, e.g.,
base money (i.e., money in circulation + bank reserves) as
a measure of money supply, or short-term interest rate.
– Interest rate / inflation targeting requires development of the
money market.
– Standing accommodation facility should not be overly relied
upon.
Framework for monetary
operations – 2

Inflation targeting requires intermediate targets, e.g.,
interest rate.

Interest rate targeting: Target at short-term rate, e.g.,
overnight call, because:
– Banks try to make final adjustments to their liquidity positions in
the O/N market, and the market thus reflects the aggregate
demand and supply of money of the day; i.e., Central Bank can
best influence the rate by controlling the liquidity;
– O/N rate hardly impacts on the formation of the market
expectation on the future course of the economy (i.e., the
market expectations for the future course of economy should be
left in the hands of the market, and Central Bank should focus on
reading it; and
– Yet, it is possible to influence the long-term interest rate
indirectly through interest rate arbitrage by market participants.
Seasonality in bank liquidity
and factors affecting it – 1

Bank reserves tend to move with seasonality.

Autonomous factors affecting them:
– Demand for bank notes; e.g., after salary pay days, before
holidays, etc.
– Changes in the government cash balance when held by the
central bank; i.e., tax and other revenues, public
expenditures and government cash funding.
– Cross border capital flows with the central bank operations
in the FX market to control abnormal exchange rate
movements.
– But “Impossible Trinity” affects.
Impossible trinity

It means the long-run (or medium term?) impossibility to
achieve the following three at the same time, i.e., can do
two but not three (Mundell – Fleming model)
– Open capital account
– Independent monetary policy (interest rate control)
– Exchange rate control

Even with liberalized capital account and exchange rate,
persisting capital inflows could cause chronic excess
liquidity, complicating the monetary policy.
Seasonality in bank liquidity
and factors affecting it – 2

The volatility of bank reserves and its seasonal cycle are
country-specific.
– Payment cycles of salaries, pension benefits, taxes differ
across countries.
– Countries also differ in the government’s ability to manage
its cash position (although MOF should strive to improve it).


Thus, Central Banks in different countries are faced with
different monetary-operational needs.
Choose such instruments, terms and frequency of OMO
that best enable Central Bank to control the countryspecific volatility and its cycle.
Some examples

Fed
– Everyday with GSs and GS/agency repos in short- and
medium-term.
– Repos in overnight to 14 days.

ECB
– Weekly auction with a floor (a deposit facility) and a ceiling
(a discount window) to create a corridor.
– Lending against a pool of eligible collateral.

BOJ
– is faced with longer cycle of larger volatility than in the US.
– Everyday
– GSs, T-bill repos, lending against a pool of eligible collateral.
Bank liquidity projection and
M-policy transparency

Estimate medium- and short-term liquidity shortages and
surpluses.
– E.g., quarterly, monthly, weekly, daily and intra-daily.
– Demand for bank notes: Historical data for medium-term
projections and compilation of short-term projections from
commercial banks for short-term projection.
– Govt cash positions: Projections from spending authorities,
i.e., line ministries, for medium-term projection and
commitments for short-term projection. Adoption of accrual
accounting to the Government could help for the latter.

Disclose actual liquidity shortages / surpluses and OMOs
performed against them.
– To enhance the transparency of M-policy.
Impacts of Govt cash
management with T-bills

Pre-funding cash shortages with issuance of T-bills and
prepaying surpluses by redeeming them will reduce the
volatility of the govt cash balance and, therefore, of the bank
liquidity.
 It reduces the operational burden of Central Bank.


To do so, MOF needs to become able to accurately estimate
future revenue inflows and expenditure outflows to project
future cash balances.
Central Bank needs to know about not only the expected
seasonality in the future cash balance of the Government but
also its plan to manage it in order to prepare itself to manage
the bank reserves effectively.
 Systematic coordination / communication is needed between
Central Bank and MOF while maintaining their policy
independence (i.e., fiscal and monetary).
Remuneration and
management of Govt deposits



Central bank may remunerate Govt deposits at a rate
benchmarked against overnight inter-bank rate or a rate
offered by commercial bank for balances in demand
deposit account.
Govt may be allowed to deposit its cash balance at
commercial banks to earn interest.
Transfer of the volatile part of Govt cash balance to the
banking sector will counteract the seasonality in the
reserve balance of the banking sector.
– E.g., Bank of Canada auctions excess Government cash
balance in the inter-bank market on behalf of the
Government.
Choice of instruments for
OMO – 1

It is a function of:
– characteristics (volatility and cycle) of the seasonality of
bank liquidity, and
– instruments available in the market and on the book of
Central Bank.


The seasonality cycle should be a point of reference in
determining terms of OMO instruments including repos.
The volatility is a benchmark for determining the
frequency of operations, which should in turn be a point
of reference for agility of instruments required.
Choice of instruments for
OMO – 2

Consider such qualities of instruments as:
–
–
–
–
–

high creditworthiness,
agility*,
high tradable volume and market depth,
term,
simplicity
Instruments to sell:
– Central bank assets, e.g., GS
– Central bank liabilities, e.g., SBI

Instruments to buy
– GS, SBI
– central bank credits against appropriate collateral
– CP?, CD?, banker’s acceptance?, promissory notes?
Choice of instruments for
OMO – 3

“Agility” of instrument is determined primarily by the
administrative efficiency of its delivery. E.g.,
– instruments supported by the inter-bank payments system
and the central securities depository / registry for paperless,
automated processing and settlement,
– those not requiring movements and administration of
collaterals, etc.
– E.g., outright purchase and sale of GS or Central Bank bills

Counterparties can differ depending on the instrument
used.
– Securities companies can grow to become important
counterparties in GS repos, e.g., US, Japan.
– Banks will continue to be primary counterparties for Central
Bank bills operations.
Government securities repos

A popular instrument for OMO.

Multiple yield/price auction for repos and reverse repos.


Meet most requirements to be an OMO instrument except
management of collateral.
Classic repos and Sell & Buybacks (SBB)
– For classic repos, MRA should enable closed-out netting to provide
protection to the creditor (i.e., buyer) in repo particularly in a civil
code jurisdiction.

Maturities differ widely among countries because characteristics
of the seasonality differ.
– Fed: 1 – 14 days.
– BOJ: typically 1 – 3 months.
T-bill repos


Discount instruments like T-bills are easy to use for repos.
However, T-bills must be abundantly available. To do so,
MOF needs to establish a T-bill “program”; i.e., MOF needs
to enhance the cash management.
Govt needs a Treasury Single Account in Central Bank.
– Govt should concentrate its cash balance in TSA except the
cash required for immediate budget execution which can be
kept at commercial banks (but not to earn interest with idle
cash balance).

Types of transactions used? Outright or Repo.
– T-bills repos would be useful for day-to-day operations in the
market.
– Outright purchase of GS for provision of growth money.
Central Bank operations


Target at short-term interest rate by influencing the level of
excess reserves of the banking system.
Avoid impacting on the yield of the instruments used and
focus on guiding the short-term target rate.
– i.e., should be instruments with market depth and volume.


One month Central Bank bills may be replaced with one
month repos.
A greater challenge in excess liquidity environment may be
to reduce the reliance on a liquidity accommodation facility.
– By using short-term repos for fine tuning (e.g., O/N repos?)
Or, else?

Reliable projection of government cash positions is critical.
Thank you