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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
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 2
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… Billion USD 2005 2006 Current A/C -7. 9 Net capital movement 2007 Q 1 Q 2 H 1 3. 2 4. 9 1. 3 6. 2 12. 6 7. 9 -3. 5 0. 5 /1 -3. 0 /2 11. 0 16. 8 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. 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 Of which: Non-Bank 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 2006 YTD (End Sep 07) THB 14. 9 4. 2 IDR 9. 3 -1. 6 SGD 8. 5 3. 2 KRW 8. 4 1. 6 PHP 8. 1 8. 7 MYR SGD MYR 7. 1 3. 6 INR CNY 3. 3 4. 1 PHP INR 1. 8 11. 2 TWD 0. 7 -0. 2 HKD -0. 3 0. 2 HKD TWD CNY IDR KRW THB
6 The appreciation momentum, especially in 2006, hardly reflected our economic fundamental FX appreciation 2006 GDP growth 2006 0. 3 Hong Kong Taiwan India China Malaysia Philippines Korea Singapore Indonesia Thailand 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
Thailand adopts inflation targeting framework (since May 2000) Framework Strategy Implementation Ultimate target Intermediate target Price stability Expected inflation Sustainable growth (Core inflation of 03. 5% quarterly average) Operating target Policy interest rate (1 -day RP rate) Instruments Reserve requirement Open Market Operations (OMOs) Standing facilities 9
10 Thus far, inflation developments have been well contained Annual percentage change FX target. Monetary target Core Inflation Headline Inflation target Target: 0 – 3. 5% 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.
The BOT sterilized mainly via issuance of BOT bonds, FX swap and repurchase operations Bln Baht 12 Mln USD RP FX Swap Outstanding (RHS) BOT Bills/Bonds Source : BOT
The BOT has been able to keep the policy rate at its target with very little volatilities 13 % Source : BOT
14 III. Implications on financial market development
The increased role of domestic bond market in Thailand facilitates the use of debt securities as a monetary instrument % of GDP 15 Thai Financial System Source: Thai. BMA
16 Monetary operations can and do play an important role in enhancing development of financial market Ø Markets in which central banks operate normally gain more depth and breadth – E. g. the rapid growth in Australian repo market since 1990 s when the RBA started using repo.
The BOT has consciously chosen its monetary operations to also further market development 17 Trading volume in private RP market Mln Baht Ø Repurchase operations § Plan for BOT RP closure is in place § Bilateral RP operations between the BOT and PDs are designed to help promote the private RP market Source : BOT
BOT bills/bonds are playing increasingly larger role as monetary instruments 18 Composition of OMOs Used (Liquidity Withdrawal) End -2003 Total 415 bil. Baht End -2006 Total 1, 270 bil. Baht Source : BOT
19 BOT bonds/bills outstanding has risen steadily, corresponded to the rise in international reserves accumulation Source : BOT
Issuance of BOT bonds/bills are similarly designed to also further market development Ø 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 ü provide regular and predictable supply ü reduced auction frequency and consolidation to reduce number of issues to facilitate secondary market trading ü Introduce new products such as FRN 20
BOT bonds have a wide investor base and contributed to the growth of mutual funds industry Source : BOT Source : AIMC 21
22 BOT papers have become the most actively traded instruments Outstanding Value Daily Trading Volume Source : Thai. BMA
23 IV. Challenges & risks
Challenges & Risks 1. 2. 3. 4. Effectiveness of monetary policy BOT’s balance sheet risk Practical limit to prolonged sterilization Finding optimal balance on policies responses in face of large inflows 24
25 1. Effectiveness of monetary policy Ø Excess liquidity could impair transmission mechanism ü ü weaken interest rate channel could lead to a reduction in short-term interest rates and have consequences for inflation Ø Two implications of excess liquidity at the ‘macro’ level ü ü 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 Ø Both size and composition of the BOT balance sheet has changed substantially reflecting largescale sterilized FX intervention. Ø Large currency mismatch led to large FX revaluation losses last year. Ø Effective communication is the key to preserve credibility.
3. Practical limit to sterilization Ø The BOT Act limits instrument flexibility ü The BOT cannot pay interest on any deposits placed at the central bank Ø Stage of market development may constrain operations ü under-developed market for interest rate hedging tools could compromise large sales of central banks’ papers ü With ever-larger scale of sterilization needed, the challenge is to keep all operations market-friendly Ø Insufficient participation in monetary operations may result in failure to achieve the operational target Ø Prolonged sterilization may not be possible without causing upward pressure on interest rates 27
4. Finding optimal balance on policies responses in face of large inflows Ø Challenges to macroeconomic management as well as financial stability ü Macroeconomic management § Combining policies of sterilised FX intervention, restriction inflows while encouraging outflows § Proper risk management is crucial 28
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 29