Monetary operation under excess liquidity

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Monetary operation under excess liquidity Powered By Docstoc
					          Challenges Facing Central Bank
                        in
Conducting Monetary Operation under Excess Liquidity
                          Presented at the
          Workshop on Developing Government Bond Market:
        The Challenges towards a Sound Monetary Management

                                              Dr. Atchana Waiquamdee
                                                      Deputy Governor
                                                      Bank of Thailand
                                                           1 Nov 2007
                                                                         2

                              Outline
I.    Sources of excess liquidity

II.   Implications on monetary management
        – Monetary policy framework: Inflation Targeting
        – Monetary operation: Sterilization

III. Implications on financial market development
       – Choosing monetary instruments to further market development
       – Side effects of taming surges in inflows

IV. Challenges & risks
      – Effectiveness of Monetary policy
      – Central bank’s balance sheet risk
      – Practical Limits to sterilization
      – Finding optimal balance on policies responses in face of large
          inflows
                                 3




I. Sources of Excess Liquidity
                                                                                4
             Foreign exchange inflows have been large and persistent,
        from both current account surpluses and non-bank capital inflows…

                                                            2007
                Billion USD            2005   2006
                                                     Q1      Q2        H1

Current A/C                            -7.9   3.2    4.9     1.3       6.2

Net capital movement                   12.6   7.9    -3.5   0.5 1/    -3.0 2/

  Of which: Non-Bank                   11.0   16.8   2.6    2.6 1/    5.2 2/

               - FDI                   7.4    10.5   2.1    1.8 1/    3.9 2/

               - Portfolio             2.6    4.5    0.9    0.7 1/    1.6 2/

               - Other Loans           -1.3   2.9    0.3    -0.4 1/   -0.1 2/

               - Trade credit          2.3    -0.3   -0.5   0.8 1/    0.3 2/

               - Other                 -0.1   -0.7   -0.1   -0.3 1/   -0.4 2/

Overall balance                        5.4    12.7   3.3     2.3       5.7

Reserves                               52.1   67.0   70.9   73.0      73.0
Note : 1/ Apr-May 07
       2/ Jan-May 07
Source: Compiled by Bank of Thailand
                                                                                                                          5

                 …causing Thai baht to appreciate rapidly.

  1 Jan 06 = 1                                                                       % change in exchange rate against USD

1.05                                                                                                           YTD
                                                                                                     2006   (End Sep07)

                                                                                              THB    14.9       4.2
1.00
                                                                                        HKD
                                                                                        TWD   IDR     9.3      -1.6

                                                                                              SGD     8.5       3.2
0.95
                                                                                        CNY   KRW     8.4       1.6
                                                                                        IDR
                                                                                        KRW   PHP     8.1       8.7
0.90
                                                                                        MYR
                                                                                              MYR     7.1       3.6
                                                                                        SGD
                                                                                        INR   CNY     3.3       4.1
0.85
                                                                                        PHP   INR     1.8      11.2
                                                                                        THB
                                                                                              TWD     0.7      -0.2
0.80
  1/1/2006   1/4/2006   1/7/2006   1/10/2006   1/1/2007   1/4/2007   1/7/2007   1/10/2007     HKD    -0.3       0.2
                                                                                                                    6

            The appreciation momentum, especially in 2006,
              hardly reflected our economic fundamental

            FX appreciation 2006                               GDP growth 2006


                                                    0.3   HK


                                                                                6.8                   Hong Kong

                                                   -0.7   TW



                                                                 4.7                                  Taiwan

                                            -1.8           I
                                                           N
                                                                                            9.1       India

                                     -3.3                 CH



                                                                                                  11.1 China
                         -7.1                             MY



                                                                          5.9                         Malaysia

                      -8.1                                PH



                                                                         5.5                          Philippines
                  -8.4                                    KR



                                                                     5                                Korea

                 -8.5                                     SG


                                                                                      7.9             Singapore

               -9.3                                        D
                                                           I




                                                                         5.5                          Indonesia

-14.9                                                     TH



                                                                 5                                    Thailand

 -15           -10              -5                        0      5                          10                 15



  Source: CEIC and Bloomberg
                                                                    7
   Foreign exchange intervention to prevent excessive
exchange rate volatility resulted in reserves accumulation




                                                     Source : BOT
                               8




II. Implications on monetary
         management
                                                                                  9
         Thailand adopts inflation targeting framework
                      (since May 2000)

                                  Framework




             Strategy                              Implementation



 Ultimate               Intermediate       Operating
                                                              Instruments
  target                    target          target



  Price                                                    Reserve requirement
                  Expected inflation          Policy
 stability                                                    Open Market
                 (Core inflation of 0-     interest rate       Operations
Sustainable         3.5% quarterly                              (OMOs)
                        average)         (1-day RP rate)
  growth                                                    Standing facilities
                                                                                                                                                                                                                                     10

                   Thus far, inflation developments have been well contained

Annual percentage change
 14

                   FX target Monetary target                                                                                                   Inflation target
 12


 10


  8
                                                                           Core Inflation
  6


  4                                                                                                                                 Target: 0 – 3.5%
  2
                            Headline Inflation
  0


  -2
       Jan 1995
                  Jul
                        Jan 1996
                                   Jul
                                         Jan 1997
                                                    Jul
                                                          Jan 1998
                                                                     Jul
                                                                           Jan 1999
                                                                                      Jul
                                                                                            Jan 2000
                                                                                                       Jul
                                                                                                             Jan 2001
                                                                                                                        Jul
                                                                                                                              Jan 2002
                                                                                                                                         Jul
                                                                                                                                               Jan 2003
                                                                                                                                                          Jul
                                                                                                                                                                Jan 2004
                                                                                                                                                                           Jul
                                                                                                                                                                                 Jan 2005
                                                                                                                                                                                            Jul
                                                                                                                                                                                                  Jan 2006
                                                                                                                                                                                                             Jul
                                                                                                                                                                                                                    Jan 2007
                                                                                                                                                                                                                               Jul
                                                                                                                                                                                                                   Source : BOT
                                                                        11

            Monetary Operations Framework


   BOT is responsible for maintaining money market liquidity at
    a level consistent with the policy interest rate set by the
    MPC.

   Monetary operations comprises 3 main components:
     1. Reserve requirements
           –   1% of which is in the form of non-remunerated deposits
               at the BOT
     2. Open market operations
           –   Repo
           –   Outright buy/sell of government securities
           –   Issuance of BOT Bills/bonds
           –   FX Swap
     3. Standing facilities
           –   Interest rate corridor of +/- 50 bps.
                                                                                                                                                                                                               12
         The BOT sterilized mainly via issuance of BOT bonds,
                FX swap and repurchase operations
Bln Baht                                                                                                                                                                                     Mln USD
   0                                                                                                                                                                                                   0


                                                                                                                                                                                                       2000
 -200
                                                                                                                                                  RP
                                                                                                                                                                                                       4000
 -400
                                                                                                                                                                                                       6000
                                                                                                                              FX Swap Outstanding
 -600                                                                                                                         (RHS)
                                                                                                                                                                                                       8000


 -800                                                                                                                                                                                                  10000


                                                                                                                                                                                                       12000
-1000
                                                                                                  BOT Bills/Bonds                                                                                      14000

-1200
                                                                                                                                                                                                       16000


-1400                                                                                                                                                                                                  18000
                                   Apr-06




                                                                       Aug-06




                                                                                                                                                Apr-07




                                                                                                                                                                                    Aug-07
                          Mar-06




                                                                                         Oct-06




                                                                                                                                       Mar-07
                 Feb-06




                                            May-06

                                                     Jun-06

                                                              Jul-06



                                                                                Sep-06




                                                                                                                              Feb-07




                                                                                                                                                         May-07

                                                                                                                                                                  Jun-07

                                                                                                                                                                           Jul-07
        Jan-06




                                                                                                   Nov-06



                                                                                                                     Jan-07




                                                                                                                                                                                              Sep-07
                                                                                                            Dec-06




                                                                                                                                                                                         Source : BOT
                                                                               13
           The BOT has been able to keep the policy rate at its target
                          with very little volatilities

 %
5.50                                                        1D RP
                                                            14D RP
5.00                                                        Interbank O/N


4.50



4.00



3.50



3.00
  Jan-06     Mar-06   Jul-06   Sep-06   Dec-06   Mar-07   Jun-07     Sep-07


                                                                    Source : BOT
                                 14




III. Implications on financial
      market development
                                                                                                   15
           The increased role of domestic bond market in Thailand
        facilitates the use of debt securities as a monetary instrument

% of GDP
140
                             Thai Financial System
120

100

 80

 60

 40

 20

  0
      1994   1995   1996   1997   1998   1999   2000   2001   2002   2003     2004   2005   2006
                      Banking sector            Domestic Bond               Stock market
                                                                                     Source: ThaiBMA
                                                               16
    Monetary operations can and do play an important role in
          enhancing development of financial market

 Markets in which central banks operate
  normally gain more depth and breadth
   –   E.g. the rapid growth in Australian repo market since
       1990s when the RBA started using repo.
                                                                                                    17
        The BOT has consciously chosen its monetary operations
                  to also further market development

                                    Trading volume in private RP market
                                Mln Baht
                                 35000

 Repurchase operations
                                 30000
    Plan for BOT RP closure
     is in place                 25000

    Bilateral RP operations     20000
     between the BOT and
     PDs are designed to help    15000
     promote the private RP
                                 10000
     market
                                  5000

                                     0
                                     May-04   Nov-04   May-05   Nov-05   May-06   Nov-06   May-07




                                                                                    Source : BOT
                                                                     18
   BOT bills/bonds are playing increasingly larger role
                as monetary instruments

Composition of OMOs Used (Liquidity Withdrawal)

     End -2003                          End -2006
 Total 415 bil. Baht               Total 1,270 bil. Baht

          RP                                    RP
          9%                         FX Swap   10%
                                       19%

FX Swap
                BoT
  48%
               Bills/Bo
                 nds
                 43%
                                                BoT
                                               Bills/Bo
                                                 nds
                                                 71%

                                                          Source : BOT
                                                                    19
        BOT bonds/bills outstanding has risen steadily,
corresponded to the rise in international reserves accumulation




                                                          Source : BOT
                                                                        20
         Issuance of BOT bonds/bills are similarly designed
                to also further market development



   BOT bonds/bills issuance
       Requires MOF approval on overall outstanding (stipulated in
        the BOT Act)
       Admittedly, the presence of two “risk-free” issuers (BOT &
        MOF) could lead to market fragmentation, but the Public Debt
        Management Act does not allow MOF to issue for BOT)
       Thus, BOT coordinates closely with MOF on issuance schedule
        with market development objective in mind
            provide regular and predictable supply
            reduced auction frequency and consolidation to reduce
              number of issues to facilitate secondary market trading
            Introduce new products such as FRN
                                                           21
     BOT bonds have a wide investor base and contributed
           to the growth of mutual funds industry




Source : BOT                 Source : AIMC
                                                                                                                                          22

             BOT papers have become the most actively traded instruments


                    Outstanding Value                                                  Daily Trading Volume
Bln. Baht
                                                                  Bln. Baht

4,500                                                              4,500

4,000                                                              4,000

3,500                                                              3,500

3,000                                                              3,000

2,500                                                              2,500

2,000                                                              2,000

1,500                                                              1,500

1,000                                                              1,000

  500                                                               500

  -                                                                  -
            2000   2001   2002   2003   2004      2005   2006                 2000   2001    2002       2003   2004      2005      2006

              Government Bonds          T-Bills           State Enterprise Bonds            BOT Bonds            Corporate Bonds


                                                                                                                      Source : ThaiBMA
                         23




IV. Challenges & risks
                                                  24

         Challenges & Risks


1.   Effectiveness of monetary policy
2.   BOT’s balance sheet risk
3.   Practical limit to prolonged sterilization
4.   Finding optimal balance on policies
     responses in face of large inflows
                                                                 25

    1. Effectiveness of monetary policy


 Excess liquidity could impair transmission
  mechanism
       weaken interest rate channel
       could lead to a reduction in short-term interest rates
        and have consequences for inflation
 Two implications of excess liquidity at the ‘macro’
  level
       may provide unwanted stimulus and create excessive
        inflationary pressure
       central banks’ ability to effectively manage liquidity
        may be constrained relative to a liquidity shortage
        situation.
                                                      26

        2. BOT’s balance sheet risk



 Both size and composition of the BOT balance
  sheet has changed substantially reflecting large-
  scale sterilized FX intervention.
 Large currency mismatch led to large FX
  revaluation losses last year.
 Effective communication is the key to preserve
  credibility.
                                                                          27

    3. Practical limit to sterilization

 The BOT Act limits instrument flexibility
      The BOT cannot pay interest on any deposits placed at the
       central bank
 Stage of market development may constrain operations
      under-developed market for interest rate hedging tools could
       compromise large sales of central banks’ papers
      With ever-larger scale of sterilization needed, the challenge is
       to keep all operations market-friendly
 Insufficient participation in monetary operations may
  result in failure to achieve the operational target
 Prolonged sterilization may not be possible without
  causing upward pressure on interest rates
                                                             28
  4. Finding optimal balance on policies responses
               in face of large inflows


 Challenges to macroeconomic management
  as well as financial stability
    Macroeconomic management
        Combining policies of sterilised FX intervention,
         restriction inflows while encouraging outflows
        Proper risk management is crucial
                                                          29
     4. Finding optimal balance on policies responses
                    in face of large inflows


 Financial stability issue
   – Will excess liquidity lead to asset price bubbles?
   – Deal with potential buildup of imbalances early


 Ongoing balancing act between managing financial
  integration and managing exchange rates
   – The need to have sound fundamentals, transparent
     regulatory and legal frameworks, robust market
     infrastructures, efficient risk management system

				
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