Latest News:
Home » Articles
22/2/2018
|
Interest rate corridor: Modernising monetary policy
The monetary policy in Nepal is quite a new phenomenon as its public announcement was started only recently. The monetary policy is announced publicly regularly since the enactment of the new Nepal Rastra Bank (NRB) Act in 2002.
[Views:79 ][Comments:0]

Under the interest rate corridor (IRC) framework, the central bank sets the floor and ceiling of policy rate and lets other money market rates such as interbank rate move within this floor and ceiling

Monetary policy is considered one of the key macroeconomic policies in economic theory. The role of monetary instruments in price stability, thereby for economic stability, is substantial in the modern economic policy making. As the financial markets are more developed and integrated, the impact of monetary policy becomes even more important in the economy.

The monetary policy in Nepal is quite a new phenomenon as its public announcement was started only recently. The monetary policy is announced publicly regularly since the enactment of the new Nepal Rastra Bank (NRB) Act in 2002.

Modernisation of monetary policy was started along with the financial sector liberalisation. Even if some of the instruments of monetary policy such as cash reserve ratio were in place since 1966, open market operations like injecting and mopping up liquidity were started only in 1989.

In the same year, the interest rate was deregulated, allowing the market to determine both deposit and lending rates. Standing liquidity facility was introduced only in 2004.

Interest rate is a significant variable of monetary policy as the rate influences the demand of and
supply for money. Many central banks thus opt for the interest rate as an effective instrument of monetary policy transmission from the monetary sector to the real sector. Most of the central banks now follow the interest rate corridor (IRC).

IRC is a system of open market operations aimed for liquidity injection and mop-up. Under the IRC framework, the central bank sets the floor and ceiling of policy rate and lets other money market rates such as interbank rate move within this floor and ceiling.

As both ceiling and floor rates of liquidity operations are set by the central bank, it is thought that central bank can better influence the market interest rates in the liberal market.

The NRB as a monetary authority and financial regulator is also gradually modernising the monetary policy. The plan of introducing a new instrument as an operating target of monetary policy was mentioned in the annual monetary policy statement of 2012. However, it took some years to formally introduce the new instrument.

The IRC was announced in the monetary policy statement of 2016/17. The primary objective of introducing corridor system was to stabilise the short term interest rates and modernise the monetary management.

At that time, both floor and ceiling was flexible, thus floor and ceiling of policy rates also moved as per the market rates. Improving this weakness, this year’s monetary policy statement has taken a step further and both floor and ceiling of the corridor has now been fixed.

Under this framework, the liquidity of banking system is being managed. The open market operation is conducted on a daily basis, if needed, which was once a week before the IRC was introduced. Thus, this system does not allow having surplus liquidity in the system and facilitates banks and financial institutions (BFIs) to borrow at fixed repo rate if liquidity tightens.

In the present corridor system, standing lending facility rate acts as a ceiling of the corridor while two-week deposit auction rate acts as the floor. Both rates are fixed by the central bank. The repo rate is set as the central bank’s policy rate and it’s now fixed at 5 per cent. If the interbank rate in the financial market goes beyond 5 per cent, the NRB injects liquidity so as to bring down the interest rate; while if the interbank rate goes down 3 per cent, the NRB mops up liquidity from the system. It is expected that short-term interest rates like interbank rate moves within the two-week deposit collection auction rates and the repo rate.

Thus, it should be understood that introduction of corridor should not allow to have excess liquidity in the financial system like before. If banks have excess money, they can deposit in the NRB at 3 per cent rate, while in case of shortage, the NRB offers money at 5 per cent interest rate.

Since BFIs are the counterparties of monetary policy implementation, they should act within this corridor responsibly. Recent banking issue of credit crunch should also be addressed through the action in the IRC while the NRB conducts market operations. This will be beneficial for both the financial intermediaries and the overall economy.

Although the deposit collection and repo facilities are still not standing, meaning that the NRB should call for both, this is the ultimate path of the corridor. Some issues of IRC like cost implications of deposit facility and lack of enough security for repo should be addressed in the days to come.

To sum up, the IRC is a modern monetary policy instrument for effective management of liquidity and interest rate stability, indicating the monetary stance to the market. The width of the IRC is crucial in determining interest rate spread. It is needed to avoid the relative demerits of both too narrow and too wide corridors. A wide corridor may encourage banks for liquidity hoarding while a narrow corridor may discourage the interbank trading and pressurise the central bank lending facility. Since the IRC is new practice for Nepali banks, they should act wisely to support the NRB in managing liquidity.

Bhatta is deputy director of Research Department, Nepal Rastra Bank

source: the himalayan times, 23 jan 2018

2018-01-23

     COMMENTS
     Recommendations

COMMENTS

No Posts Yet...

  • FinancialNepal

Post a comment

* marked are required fields

*Name:
*Email Address:
*City:
*Comments
In order to help us prevent automated submissions, please type the number shown in below picture
*Validation no.
captcha

Connect with us
Would you like to advertise here?
Civil Homes Projects
Brihat housing
Home loan application