Thursday, May 19, 2022

New Monetary Policy Operations: Small steps in a dark room

Botswana’s Headline Inflation is in double digits since January 2022 and needs taming. But that is just part of what the central bank is currently battling with. Beyond prices control, the Bank has finally admitted to the need to “enhance potency of monetary policy transmission”. Judging by the anticipated changes in the banking industry, the Central Bank has an ideal and ‘desired’ market response to some of the adjustments it makes to the monetary policy and operations.

A hint of the small steps that the country will have to make in a dark room was shared by the Governor – Moses Pelaelo at the launch of the 2022 Monetary Policy Statement in late February. Pelaelo said that the central Bank is evaluating, on a continuous basis, the monetary policy implementation framework for effectiveness, “as may be necessary.”

In that respect, during this year, the Central Bank, Pelaelo said, will introduce further improvements and changes to monetary policy operations with three main objectives.

According to Pelaelo, the reforms seeks, to amongst other things, “to designate an anchor policy rate capable of affecting liquidity management decisions of banks, and thus providing a direct link to policy changes”. The anticipated changes also seeks to achieve an interest rate structure that fosters an active interbank market that also projects the policy stance and desired impact of monetary operations on economy wide interest rates.

While the exact date has not been set yet, given the need to consult with stakeholders including commercial banks, it is an open secret that the central bank will introduce new reforms on its Monetary Policy Framework in the first half of 2022. Amongst the proposed changes is the replacement of the key bank rate with a Monetary Policy Rate based on the seven-day Bank of Botswana Certificate yield.

Industry Responds…

Salma Baduel – Country Treasurer at Absa Bank Botswana says the BSE quoted banker sees the central bank’s announcement as a positive development for the market. Baduel says the developments will result in enhanced monetary policy transmission as well as have a positive influence on liquidity management decisions of commercial banks.

The proposed changes, according to Absa Bank, are not designed to have a negative impact on customers and commercial banks as the fundamentals of the determination of the new prime lending rates (PLR) remain unchanged. 

As it has emerged that the central bankers also want to change the auction format for the main monetary operations instrument (the BoBCs) from the current multiple price system to a fixed rate full allotment system, the First National Bank Botswana (FNBB) says switching to this system is hoped to promote interbank activity, “with the central bank reducing the frequency of liquidity absorption and injection activities to at least semi-monthly, conducted at the new Monetary Policy Rate (MPR).”

FNBB’s quantitative analyst – Gomolemo Basele says the objective of the consultations between the central bank and commercial banks were aimed at strengthening the transmission of monetary policy and are expected to improve the signal provided by the announcement of the policy rate and resulting market reaction.

“Given this 5.25% cap, with the 7-day BoBC rate currently at 1.12%, puts pressure on loans and deposits to reprice lower, in the absence of any upward revisions in the 7-day BoBC rate. However, no prescriptions have been applied yet to the margin over prime that commercial banks can apply in their pricing”, says Basele.

While the country’s leading commercial banks have signaled a green light to the proposed changes, of significant importance to borrowers and lenders alike is that the central bank intends to allow bankers to independently determine their own Prime Lending Rates (PLR).

Pelaelo said the move-away from the current regime where the bank sets the Prime lending rate will, “foster the development of a competitive financial sector”.

Absa’s Baduel also echoes the same. “We believe these developments will result in enhanced monetary policy transmission as well as having a positive influence on liquidity management decisions of commercial banks”.

To ensure an orderly and smooth transition as well as treatment of pricing of existing financial contracts and other products linked to industry prime lending rate, Pelaelo and his team at BoB have ordered that the current PLR of 5.25 percent should not be changed by any bank except in the event of an adjustment by the Monetary Policy Committee of the signaling policy rate (to be called the Monetary Policy Rate).

In response, FNBB’s Basele says given this 5.25 percent cap, with the 7-day BoBC rate currently at 1.12 percent, this puts pressure on loans and deposits to reprice lower. Basele’s comment is however based on an analysis that looks at the absence of an upward revision in the 7-day BoBC rate. He draws comfort on the fact that, “No prescriptions have been applied yet to the margin over prime that commercial banks can apply in their pricing.”

The latest move by the central Bank to enhance the transmission of monetary policy comes as analysts have noted that monetary policy measures such as the lowering of the bank rate have not always resulted in the expected higher credit uptake required in lifting demand in the economy. While in other jurisdictions lower interest rates have been used to boost consumers’ appetites for credit, in Botswana, commercial banks pushed their liquidity into the BoBCs. Most bankers classify BoBCs as risk-free compared to retail consumers. Faced with such uncertainty, there is a case for the central bank to accompany the anticipated changes with a light touch, taking moderate and careful steps in adjusting policy, so as not to suffocate the country’s incomplete economic recovery.

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