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Monetary Policy and its impact in Pakistan
- 1. MONETARY POLICY AND ITS IMPACT ON FS 1
- 2. MONETARY POLICY: DEFINITION “Monetary policy refers to actions undertaken by a central bank to regulate the money supply and influence interest rates in order to achieve macroeconomic objectives.” 2 2
- 3. MONETARY POLICY COMMITTEE: CONSTITUTION - PAKISTAN The committee members include: Governor SBP (Chairperson) 3 Senior Executives (Nominated by Chairperson) 3 Members of SBP board 3 External Members (Nominated by GoP)
- 4. POLL How many MPCs held in a year in Pakistan?
- 5. MONETARY POLICY: OBJECTIVES 5 Price Stability: Maintaining stable prices by controlling inflation is a key goal of monetary policy. Rapid price increases erode purchasing power and can lead to economic instability Full Employment: Monetary policy aims to achieve maximum sustainable employment. Central banks influence economic activity by adjusting interest rates and credit availability. Lowering interest rates can stimulate borrowing, spending, business investment, and job creation. Economic Growth: Central banks promote sustainable economic growth by maintaining stable financial conditions. Adjusting interest rates and influencing credit availability encourage investment, consumption, and overall economic activity. Exchange Rate Stability: Central banks may target exchange rate stability in economies with flexible exchange rates. Exchange rate fluctuations impact trade balances, inflation, and financial stability. Central banks intervene in foreign exchange markets to stabilize rates or implement policies indirectly affecting currency values.
- 6. MONETARY POLICY: TOOLS Open market operations: buy or sell government securities to influence the money supply and interest rates in the economy. Reserve requirements: Mandated amounts of reserves that banks must hold against their deposits, influencing the amount of lending and money creation by banks. Discount Rates: The interest rate at which commercial banks borrow funds from the central bank, affecting the cost of borrowing and lending throughout the economy. Currency Intervention: Direct buying or selling of domestic currency in foreign exchange markets to influence exchange rates and stabilize the currency's value. Quantitative Easing (QE): Large-scale purchases of financial assets by central banks to increase the money supply and lower long-term interest rates. Forward Guidance: shapes market expectations and economic behavior by communicating future monetary policy intentions, including interest rate decisions, asset purchases, and other policy actions.
- 7. POLL What is an interest rate corridor?
- 8. MONETARY POLICY: DISCOUNT RATE Banking sector generates revenue through overnight lending. This Repo and Reverse Repo lending is governed by the interest rate corridor. The interest rate corridor operates between 200 Bps. Policy Rate: 22% SBP Overnight Repo (Floor): 21% SBP Overnight Reverse Repo (Ceiling): 23%
- 9. MONETARY POLICY: OMO Open Market Operation is a tool used by a Central Bank (or monetary authority) to inject or mop-up funds, based on the liquidity requirements, from the banking system via the purchase or sale of eligible securities. 4 Types of OMOs: Injection – Reverse Repo: (To tackle short market positions) Mop-up – Repo (To tackle long market positions) Outright Sale or Purchase (long-term liquidity mgt.) Bai-Muajjal (Islamic mode - Deferred Payment) OMOs conducted in shorter tenors (e.g. 7 to 14 days).
- 10. MONETARY POLICY: RESERVE REQUIREMENT Reserve requirements: Mandated amounts of reserves that banks must hold against their deposits, influencing the amount of lending and money creation by banks. Cash Reserve Requirement (CRR) is a percentage of banks total liabilities or some subset thereof which banks are required to hold as reserves at the Central Bank. In Pakistan, All banks (including Islamic Banks/Branches) must maintain CRR at an average of 6.0% of total demand liabilities Banks are required to maintain 5 percent as cash reserve and 10 percent as special cash reserves against foreign currency deposits.
- 11. MONETARY POLICY: CURRENCY INTERVENTION Direct buying or selling of domestic currency in foreign exchange markets to influence exchange rates and stabilize the currency's value. Intervention can be in READY or FORWARD In Pakistan SBPs role is to: To manage the exchange rate mechanism. Regulate inter-bank forex transactions and monitor the foreign exchange risk of the banks. Keep the exchange rate stable. Manage and maintain country's foreign exchange reserves.
- 12. MONETARY POLICY: FORWARD GUIDANCE “This involves providing guidance on future interest rate decisions, asset purchases, or other policy actions, helping to shape market participants' expectations” Important tool used in forward guidance: Real interest rates: The real interest rate is the nominal interest rate adjusted for inflation. It represents the actual purchasing power gained or lost from an investment or loan after accounting for inflation. R = Nominal Interest Rate−Inflation Rate Central banks aim for a positive real interest rate when deciding on monetary policy.
- 13. POLL Which country has the highest Inflation (CPI) in the world?
- 14. POLL Which country has the highest policy rate in the world?
- 15. WHAT IS THE ROLE OF MONETARY POLICY IN PROMOTING ECONOMIC GROWTH? Keeping inflation low and stable Maintaining price stability reduces uncertainty surrounding price changes, fostering an economic environment conducive to expansion in line with production capacity. Low and stable inflation is established as a pre- condition for securing growth By adhering to these principles, monetary policy can effectively support sustainable economic growth and employment creation while mitigating risks associated with inflation volatility.
- 16. POLL Why doesn’t the central bank simply print enough money to pay off national debt?
- 17. WHY DOESN’T CENTRAL BANK SIMPLY PRINT ENOUGH MONEY TO PAY OFF NATIONAL DEBT? 17 Inflationary Impact of Printing Money to Pay Off Debt: Inflation as it increases the money supply without a corresponding increase in the production of goods and services. Diminished Value of Domestic Currency: reduction in the value of domestic currency as the increased money supply diminishes its purchasing power. Risk of Hyperinflation: In extreme cases, this practice can lead to hyperinflation, which severely undermines economic growth and the well- being of the populace. Currency Depreciation: The increase in the money supply relative to other currencies can lead to depreciation of the domestic currency against foreign currencies. Negative Repercussions: Detrimental effects on economic stability, investment, and overall prosperity.
- 18. NEGATIVE REPERCUSSION: HISTORIC EXAMPLES 18 Germany's experience after World War I, where large-scale money printing led to rampant inflation, serves as a classic example. Zimbabwe's recent history also illustrates the negative consequences of excessive money printing, leading to hyperinflation and severe economic hardships.
- 19. CAUTIONARY TALE: SILICON VALLEY BANK (SVB) 19 Timeline: Silicon Valley Bank (SVB), the 16th largest bank in America had assets worth $ 209 B. Following significant deposit growth, SVB invested funds in long-term treasury bonds, owing to relatively low risk. The Federal Reserves increased interest rates in response to high inflation, SVB’s bonds became riskier investments. Investors could now buy bonds at higher interest rates, Silicon Valley Bank’s bonds declined in value. To consolidate its portfolio, SVB sold some of its investments at a loss of $1.8 billion. This move led to a ratings downgrade by Moody. This triggered a bank run, with total attempted withdrawal of $42 B.
- 20. CAUTIONARY TALE: SILICON VALLEY BANK (SVB) 20 Bottomline: SVB misread forward looking policy rate sentiments and made ill-advised investments. Aftermath: US government announced the Bank Term Funding Program (BTFP), which now offers loans (Up to 1 year) to banks to meet depositors' needs. The program also helps to ensure that, when banks need cash, they won’t be forced to quickly sell high- quality securities to get it.
- 21. Challenges and Trade-offs in Implementing Monetary Policy Balancing Objectives: challenge of balancing multiple objectives such as price stability, full employment, and economic growth while maintaining financial stability. Time Lag: Monetary policy actions may have a delayed effect on the economy, making it challenging to accurately time policy interventions to address emerging financial stability risks. Unintended Consequences: creating asset bubbles or excessive risk-taking behavior in financial markets. Global Interconnectedness: increasingly interconnected globally, making it challenging for central banks to address financial stability risks that originate from abroad. Regulatory Arbitrage: Financial institutions may seek to circumvent regulations or exploit loopholes, leading to challenges in effectively implementing policies aimed at enhancing financial stability. Data Limitations: Limited availability or reliability of data on financial markets and institutions can hinder central banks' ability to accurately assess and monitor systemic risks. Communication Challenges: Communicating complex monetary policy decisions and their implications for financial stability to the public and financial markets can be challenging, potentially leading to market volatility or misinterpretation. Political Pressures: Central banks may face political pressures to prioritize short-term economic objectives over long-term financial stability concerns, creating tensions in policy implementation.
- 22. THANK YOU 22
Editor's Notes
- Eight times a year
- Price Stability: Maintaining stable prices and controlling inflation is often a primary objective of monetary policy. Central banks aim to keep inflation within a target range to ensure the stability of the overall economy and preserve the purchasing power of the currency. Full Employment: Promoting maximum sustainable employment is another key goal of monetary policy. By influencing interest rates and overall economic activity, central banks seek to create conditions conducive to job creation and reduce unemployment to levels consistent with long-term growth potential. Economic Growth: Central banks also aim to support sustainable economic growth by managing interest rates and credit conditions. By stimulating or moderating borrowing and spending in the economy, monetary policy can help smooth out economic cycles and promote long-term prosperity. Exchange Rate Stability: Maintaining stability in the foreign exchange market is important for trade and financial flows. While exchange rates are influenced by various factors beyond monetary policy, central banks may intervene to prevent excessive volatility or to address imbalances that could disrupt economic stability. Financial Stability: Ensuring the stability of the financial system is another objective of monetary policy. Central banks monitor and address risks to financial stability, such as excessive leverage, asset bubbles, and systemic risks, through regulatory and supervisory measures as well as monetary policy tools. Interest Rate Stability: Central banks also aim to promote stability in interest rates across various maturities. Stable interest rates support investment decisions, financial planning, and overall economic activity. These objectives may vary depending on the specific mandate and circumstances of each central bank, but they generally reflect the broader goals of promoting macroeconomic stability, sustainable growth, and financial resilience.
- Interest Rates: Central banks adjust benchmark interest rates to influence borrowing costs, spending, and investment in the economy. Lowering rates stimulates economic activity, while raising them helps curb inflation. Open Market Operations (OMO): Central banks buy or sell government securities in the open market to adjust the money supply and influence interest rates. Buying securities injects money into the economy, while selling them withdraws money. Reserve Requirements: Central banks mandate the amount of reserves banks must hold against deposits. Adjusting reserve requirements can affect the amount of money banks can lend and impact overall liquidity in the financial system. Forward Guidance: Central banks provide guidance on future monetary policy intentions to influence market expectations. This can include signaling future interest rate decisions or policy actions to shape economic behavior. Quantitative Easing (QE): In times of economic crisis or when traditional monetary policy tools are ineffective, central banks may engage in QE. This involves purchasing long-term securities to increase liquidity and lower long-term interest rates. Discount Window Lending: Central banks offer short-term loans to commercial banks through the discount window. Adjusting the discount rate affects the cost of borrowing for banks and can influence lending behavior.
- IRC is a monetary policy framework used by central banks to implement control over short-term interest rates within a predetermined range. IRC helps the central bank maintain control over short-term interest rates by influencing market rates through operations such as open market operations (OMO) and repo operations. When market rates approach the upper or lower bounds of the corridor, the central bank intervenes in the money market to bring rates back within the desired range.
- Cash Reserve Ratio (CRR) is a monetary policy tool used by central banks to regulate the liquidity in the banking system. It mandates the portion of deposits that commercial banks are required to keep with the central bank in the form of cash reserves, thus reducing the amount of money banks can lend or invest. As of my last update in January 2022, the Cash Reserve Ratio (CRR) for banks varies from country to country and is subject to change based on the monetary policy stance of the respective central bank and prevailing economic conditions. For example, in India, the Reserve Bank of India (RBI) sets the CRR for scheduled banks. As of my last update, the CRR for scheduled banks in India stood at 4% of their net demand and time liabilities (NDTL). However, this rate may have changed since then. Similarly, in Pakistan, the State Bank of Pakistan (SBP) imposes reserve requirements on commercial banks, which include both CRR and other reserve ratios. The specific CRR for banks in Pakistan is determined by the SBP and may vary depending on the prevailing economic conditions and monetary policy objectives.
- Currency intervention, also known as foreign exchange intervention or forex intervention, refers to the action taken by a central bank or monetary authority to influence the value of its currency in the foreign exchange market. These interventions can involve buying or selling domestic currency in exchange for foreign currency to stabilize exchange rates or achieve other monetary policy objectives. Here's a brief history of currency intervention: Global Financial Crisis (2007-2009): Central banks intervened heavily in currency markets during the global financial crisis to mitigate the impact of financial market turmoil on exchange rates. Many countries engaged in coordinated interventions to stabilize currencies and restore market confidence. Post-Financial Crisis Era: In the years following the global financial crisis, currency interventions remained a tool used by central banks to manage exchange rate fluctuations and support economic recovery efforts. Central banks in emerging markets often intervened to prevent rapid depreciation of their currencies. Recent Years: Currency interventions have continued to occur in response to various economic and geopolitical developments, including trade tensions, capital flows, and currency manipulation concerns. Central banks typically provide limited information about their intervention activities to avoid signaling their intentions to the market.
- Venezuela had 190% CPI in Jan 2024
- Zimbabwe has policy rate of 130% as on Jan 2024
- Due to risk of hyper inflation and currency depreciation.
- Inflationary Impact of Printing Money to Pay Off Debt: Printing money to pay off the national debt is likely to cause inflation as it increases the money supply without a corresponding increase in the production of goods and services. Diminished Value of Domestic Currency: Such actions effectively reduce the value of domestic currency as the increased money supply diminishes its purchasing power. Risk of Hyperinflation: In extreme cases, this practice can lead to hyperinflation, which severely undermines economic growth and the well-being of the populace. Currency Depreciation: The increase in the money supply relative to other currencies can lead to depreciation of the domestic currency against foreign currencies. Historical Examples: Germany's experience after World War I, where large-scale money printing led to rampant inflation, serves as a classic example. Zimbabwe's recent history also illustrates the negative consequences of excessive money printing, leading to hyperinflation and severe economic hardships. Negative Repercussions: Inflationary pressures and currency depreciation resulting from printing money to pay off debt can have detrimental effects on economic stability, investment, and overall prosperity.