|Central Bank Introduces Active Open Market Operations
The Central Bank will implement a system of market based active Open Market Operations with effect from today.
Open Market Operations (OMO) are conducted by the Central Bank, as an instrument of monetary policy to regulate the volume of money in the economy in order to achieve the final objective of economic and price stability. Under OMO depending on the requirement of monetary policy, the bank could either inject liquidity to the financial system by purchasing government securities or absorb liquidity from the system by selling out of its holdings, government securities or its own securities. In line with the Central Banks policy of moving away from non market oriented instruments (such as limits on credit and Statutory Reserve Requirement which are imposed by direct regulation) to market based instruments (which operate indirectly through supply and demand in the market) in implementing monetary policy, OMO constitutes the main instrument of monetary policy.
Under OMO the bank offers repurchase facilities (i.e. selling government securities with an agreement to buy them back at an agreed price on an agreed date) to commercial banks and primary dealers (participating institutions) to absorb liquidity on a short term basis at an interest rate known as the Repurchase (Repo) Rate. Similary, reverse repurchase facilities (i.e. buying government securities with an agreement to sell them back at an agreed price on an agreed date) are offered to inject liquidity on a short term basis. The interest rate at which this reverse repurchase facility is made available is known as the Reverse Repurchase (Reverse Repo) rate. In order to absorb or inject liquidity on a longer term basis, discounting (outright selling of government securities) and rediscounting (outright purchasing of government securities) facilities are made available to the participating institutions. At present, these facilities are offered to the participating institutions at rates of interest decided by the bank and used by the participating institutions at their own discretion.
With effect from March 3, 2003, the transactions under OMO will be conducted at rates of interest determined in the market, which is more consistent with the move towards market based instrument of monetary policy. The volume of liquidity either injected or absorbed under OMO will be decided by the Central Bank. This would enable the Central Bank to manage market liquidity more effectively to achieve its monetary policy objectives through the realization of relevant monetary targets.
Market Based Active OMO
The main features of the system are:
(i) An interest Rate Corridor,
(ii) Daily auction of either repo or reverse repo to maintain the inter bank rate stable within the corridor,
(iii) Standing facilities,
(iv) Outright buying/selling of Treasury bills/bonds at the discretion of the Central Bank to either inject or absorb long-term liquidity.
(i) Interest Rate Corridor
An interest rate corridor specified in terms of the Repo rate (lower bound currently at 9.00 percent) and the Reverse Repo rate (upper bound - currently at 11 percent) will be announced by the Central Bank. The corridor will signal the monetary policy stance of the Central Bank to the market. It will be reviewed regularly, usually at monthly intervals, against macro economic developments and prospects. At these reviews a decision will be made either to change or not to change the corridor. The decision will be announced, together with an analysis of factors that were considered in arriving at the decision. This would make the Central Banks monetary policy more transparent, enabling the market to have a better understanding of the thinking of the authorities, thereby reducing unwarranted speculation.
(ii) Daily Repo/Reverse Repo Auctions
Given the corridor, OMO will be conducted to maintain the inter bank rate stable at a level considered appropriate within the interest rate corridor. For Example, when the market is broadly in balance, ie. when banks could cover their entire liquidity requirements in the inter bank market, the appropriate level for the inter bank rate would be at the middle of the corridor. If a shortage of liquidity emerges, the inter bank rate would tend to move towards the upper bound of the corridor. In such cases, the Central Bank will inject liquidity through reverse repo auctions to cover the deficit and maintain the rate around the middle of the corridor. Similarly, if there emerges a surplus, it would be absorbed through repo auctions. The Central Bank will make an assessment of market liquidity daily and decide whether there is a need for either injecting liquidity to or absorbing liquidity from the financial system. The decision will be announced to the market and bids invited for a repo or reverse repo auction. The auctions will be on multiple bid multiple price basis where cash participating institutions could forward up to three bids per auction and allocations to successful bidders are at their bid rate of interest.
(iii) Standing Facilities
There is a possibility that even after the daily injection or absorption of liquidity by the Central Bank their could stil be banks with a deficit or a surplus. Facilities known as standing facilities will be available at the bounds of the interest rate corridor for these banks to cover their liquidity needs. Deficit banks could borrow at the Reverse Repo rate, while surplus banks could invest their surpluses at the Repo rate. Compared with the average interest rate at which liquidity facilities are offered at the daily auction, standing facilities would be at rates of interest which would encourage banks to manage their liquidity more cautiously and avoid resorting to standing facilities regularly. Banks would benefit by making an accurate assessment of their own liquidity and participating competitively at the Central Banks auctions.
(iv) Outright Buying/Selling of Treasury bills/bonds
The present practice of providing discounting (selling) and re-discounting (buying) facilities will be changed with the move to active OMO. These facilities will be made available at the discretion of the Central Bank either to absorb or inject long-term liquidity in order to address changes in long-term liquidity conditions. For example, a continuous injection of large volume of liquidity on an overnight basis by the Central Bank for a long period is an indication that there is a need for an injection of long-term (permanent) liquidity. Then, re-discounting facilities will be offered on an auction basis to inject long term liquidity.
Benefits of the Market Based Active OMO
This system has benefits to participating institutions, as well as the Central Bank. Participating institutions are benefited as OMO facilities would be available at market rates of interest, instead of administratively fixed rates. As the market rate would be within the corridor, compared with the present system, participating institutions will receive a higher rate of interest for their repurchases, while paying a lower rate for reverse repurchase facilities. Furthermore, with the market gaining experience under this system, the potential volatility of interest rates would decline as participants will improve the accuracy of their liquidity estimates and management practices.
The interest rate corridor, which signals the monetary policy stance, will be reviewed at regular intervals and the decision of the Central Bank to change or not to change the corridor will be announced with a statement analysing the underlying factors for the decision. Accordingly, market participants would be well informed, which would eliminate excessive speculation on the timing of changes in the policy stance of monetary policy.
Under this system, the Central Bank would actively manage market liquidity and hence it would be more effective in realizing its targets on monetary aggregates, which would lead to the achievement of the final target of economic and price stability in the country.
|NEWS | FEATURES |
| EDITORIAL | CARTOON | SPORTS