Backdrop for Today’s Discussion o Global macroeconomic conditions leading to extraordinary liquidity creation undertaken by the Federal Reserve, ECB, Bank of Japan and Bank of England have led to strong inflows of capital to emerging markets. o Most emerging market central banks have responded to capital inflows with foreign currency purchases thereby expanding domestic liquidity in their home markets. The bulk of this liquidity expansion has subsequently been “sterilized” (withdrawn from the market) through a variety of mechanisms including the issuance of central bank domestic debt. o While capital inflows and sterilization can be a major headache for central banks, current emerging market macroeconomic conditions present a once-in-a-lifetime opportunity to rethink cooperative central bank and treasury roles and responsibilities, refine sterilization instruments, and improve joint policy performance
Why must central banks sterilize foreign exchange purchases? (1) o Monetary policy consists of a small volume of operations designed to influence a short term interest rate target under an inflation targeting regime o In a pure Inflation Targeting (IT) regime there is no foreign exchange intervention and the central bank requires, on its balance sheet, little or no foreign exchange reserves/assets (Canada, UK, US) o Central bank liabilities consist almost entirely of banknotes while assets consist almost entirely of government debt securities o The Bank of Canada is a good illustration of the classic pure IT balance sheet
Bank of Canada Balance Sheet: Illustrates very small value of monetary operations Bank of Canada Balance Sheet (end 2006 in percent of GDP) Assets Liabilities Government Securities 3.3 Banknotes 3.4 Liquidity-providing Repos 0.2 Deposits 0.2 Other Assets 0.0 Other Liabilities 0.0 Total 3.6 Total 3.6
Why do central banks need to sterilize foreign exchange purchases? (2) o Large purchases of foreign exchange by the central bank lead to large increases in commercial bank holdings of deposits at the central bank as this is how the central bank pays for the foreign exchange. This increase in money market liquidity leads, if not sterilized, to falling short term interest rates o From an operational standpoint this is very problematic for the central bank since the credibility of an IT regime hinges on the link between short term interest rates — which must be tightly connected to the policy target — and inflation o See the discussion surrounding graph 2 (Colombia) in Filardo, Mohanty and Moreno (2012)
The Central Bank of Chile provides an illustration of an IT central bank with significant foreign exchange reserves and sterilization needs Balance Sheet of the Central Bank of Chile 31-Dec-09 (percent of GDP) Assets Liabilities Foreign reserves 14.2 Monetary base 5.4 Other foreign assets 1.1 Government deposits 0.4 Credit to commerical banks 3.9 Other deposits 3.5 Credit to other institutions 0.0 Inflation indexed central bank bonds 5.6 Fiscal bills 0.3 Peso denominated central bank bonds 2.3 Restructured emergency lending operations 1.1 Discount central bank bills in pesos 4.2 Floating rate central bank bills 0.9 Other central bank debt 0.6 Other assets 0.1 Other liabilities 0.5 Repurchase agreements 0.4 Equity -3.1 Total Assets 21.0 Total liabilities 21.0
From a market development perspective, sterilization mechanisms may differ markedly in their optimality: “good”, “bad” or “ugly” Domestic debt market may be split between treasury and central bank and o among instruments, some of which might have been introduced in the midst of a crisis and not well designed or conducive to market development Instruments that lead to fragmented and shallow markets are likely to lead to o lessened trading and higher bid-ask spreads. (See McCauley(2003)) Unlikely that “separate” central bank and treasury domestic debt management o strategies will be superior to a consolidated/integrated execution of a single strategy with a single issuer Central banks with large debts (borrowing from the market) tend to have greater o challenges in monetary management and run the risk of conflict with government debt management. Structural excess liquidity makes monetary policy more difficult. The “normal” situation is a domestic liquidity shortage but these countries must cope instead with structural excess liquidity 7
Indonesia: Having in effect two managers of domestic sovereign debt can lead to unexpected consequences Outstanding domestic debt securities by remaining maturity (Rupiah trillion, end-2008 projection) 200 150 Gov. securities SBIs 100 50 0 1 yr 3 yrs 5 yrs 7 yrs 10 yrs 15 yrs 20 yrs 25 yrs 30 yrs 1 mth 3 mth 6 mth 8
Many emerging market countries have taken measures to strengthen domestic debt management and markets in recent years Although the specifics vary from country to country the general strategy involves the replacement of central bank domestic debt instruments with treasury instruments. (Mexico,Israel, Brazil, Singapore) The reduction of market fragmentation increases liquidity in the market for the remaining instruments. Moving to a single sovereign debt manager facilitates taking a comprehensive approach toward managing sovereign domestic and foreign debt and allows monetary policy to operate without the distraction of having a “dual” operational role. This clarification of roles improves the ability of both the treasury and central bank to communicate strategies and review results with stakeholders Actions taken in the light of strategic insights obtained from an ALM perspective, as well as the enhanced use of treasury instruments for structural liquidity absorption, often result in lessened central bank losses and risk exposures. This clarifies inter-institutional fiscal relations and facilitates the presentation of central bank financial results.
Issues for Discussion o Emerging markets that are benefiting from solid economic growth, stability, and favorable conditions for capital inflows, are witnessing an unprecedented opportunity to strengthen the management of their sovereign assets and liabilities. Starting from a position of strategic strength will allow them to set the terms for reshaping and restructuring their overall financial situation o The consolidated balance sheet approach is a tool that may reveal “win win ” situations resulting in less sovereign risk, lower financing costs and/or enhanced financial stability. In other words, it may reveal the existence of superior points on the consolidated risk return frontier o Sharing “good”, “bad” and “ugly” sterilization experiences among the GEMLOC community will be very valuable! 10
Recommend
More recommend
