Chapter

Financial Sector Reform and Monetary Instruments and Operations

Author(s):
International Monetary Fund
Published Date:
March 1991
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Author(s)
R. Barry Johnston and Odd Per Brekk 

Reorienting monetary control to rely increasingly on market-based instruments is not only desirable but also inevitable when countries begin to reform their financial systems. Such reliance increases the scope and flexibility of monetary policy for stabilization purposes, while also facilitating deregulation of interest rates, a removal of direct credit controls, and the development of markets. In financial systems with extensive interest rate and credit controls and subsidies, markets are typically underdeveloped and not competitive. Financial sector reform aims at developing institutional structures and competitive markets that will enhance the mobilization and allocation of resources and support the development of market-based instruments. The development of market-based monetary control instruments need not wait for the full development of market structures, since new instruments could be introduced against the background of underdeveloped financial markets as a means to foster market development.

In the absence of secondary markets in securities and active interbank markets, the main market-oriented instrument used has been primary issues of government or central bank papers, in addition to repurchase transactions using these papers. These types of instruments are sometimes referred to as “open-market-type operations,” to distinguish them from traditional open market operations in developed secondary markets.1 Open-market-type instruments can help foster the development of money and interbank markets and act as a catalyst to bring about institutional reform and a change in attitude toward interest rate determination, credit control, and competition in the financial system, as well as providing a framework for effective monetary control. The introduction of open-market-type operations is often accompanied by a redesign and adaptation of traditional monetary controls, such as reserve requirements and refinance policy. While the introduction of indirect instruments has helped to foster money and interbank markets, their effective adoption also has required parallel reforms to foster appropriate market institutions, competitive trading arrangements, and payment settlement facilities that will ensure a smooth functioning of these markets.

This chapter examines the background to the development of market-based monetary control and reviews experiences with these instruments in selected developing countries. It first discusses some of the problems with direct controls that have led to a greater reliance on indirect approaches to monetary control. It then reviews the framework for market-based control, with reference to the procedures followed in certain industrial countries. Afterward, this section examines procedures for developing market-based systems of monetary control in financial systems that are initially underdeveloped, and describes the development and experiences with the use of such systems in a sample of developing countries. Finally, it discusses some of the operational implications of the increase in capital flows.

Country experiences confirm that early introduction of indirect instruments can help stimulate money markets and provide a strong support for stabilization policies, thereby facilitating the process of interest rate liberalization. The close technical and operational linkages between monetary operations, money market structures, and features of payment systems suggest that reforms in these areas may have to be implemented in a well-coordinated manner to support both stabilization and financial liberalization.

Difficulties with Systems of Direct Monetary Control

The systems of direct monetary control used in most countries at one time or another typically involve some if not all of the following elements: direct controls on interest rates (including minimum and maximum interest rates, and preferential rates for certain loan categories); aggregate and individual bank credit ceilings; selective credit controls and preferential central bank refinance facilities to direct credit to priority sectors; and high reserve and liquid asset requirements, designed both to absorb liquidity and to provide government deficit financing.

When properly implemented and monitored, direct instruments of monetary control can be useful in achieving narrowly defined targets, such as maintaining a particular interest rate at a certain level, or keeping a bank’s overall credit expansion below a certain ceiling. But the macroeconomic impact of the controls is unpredictable because of the scope for evasion and avoidance, and the controls also distort the allocation of resources. In addition, direct controls are administratively difficult and costly to design and implement efficiently and effectively over a prolonged period of time.

Credit ceilings and other direct controls operate by forcing banks into portfolio positions that they would not voluntarily accept. Hence, banks have incentives to avoid the direct controls. Effective credit ceilings normally involve a buildup of excess liquidity, which discourages deposit taking by regulated institutions, and in turn inhibits savings mobilization or causes disintermediation. In either case, the effectiveness of monetary control may be diminished.2

The erosion of effective monetary control that occurs with prolonged use of credit ceilings may not be avoided by mandating positive real interest rates at the regulated institutions. It is generally not possible to control both the cost and quantity of credit, although in practice this is what is attempted by the use of a combination of credit and interest rate controls. If the mandated deposit rates are set too high relative to the capacity to use funds under the credit ceilings, regulated institutions may either turn away depositors or find ways of paying lower effective deposit rates—for example, by increasing fees or tightening conditions on withdrawal of funds to discourage deposit mobilization.

The use of direct credit and interest rate controls can also disrupt the efficient allocation and mobilization of financial resources. First, banking system competition is often inhibited by the credit and interest rate controls. Banks will have little incentive to compete on services; and the controls may encourage collusive behavior in setting commissions and charges. Inefficient institutions would lead to higher average transaction margins and lending spreads.

Second, the incentive to price credit according to risk is often lacking when interest rates and credit are subject to direct regulation. As a result, financial resources may not be directed into those activities expected to yield the highest returns, which is detrimental to economic growth, and banks’ balance sheets may be weakened by an underpricing of risks. High liquid asset ratios, which create captive markets for government securities, can also result in an inappropriate pricing of credit.

Third, under systems of direct interest rate and credit controls, little attention is often paid to the development of money and capital markets—both critical factors in the efficient mobilization and allocation of financial resources from the private sector, both domestic and international. Within a regulated system, the existence of money and capital markets could undermine the credit and interest rate controls by providing alternative outlets and sources of funds outside the administered system. Commercial bank credit, however, has normally been of a short-term, revolving nature, and not suited for financing longer-term investment projects.3 As a consequence, the volume of long-term finance may be impaired, while the lack of a range of financial instruments differentiated by maturity, risk, and liquidity may discourage private savings.

Fourth, direct credit and interest rate controls are usually inconsistent with freedom of international capital movements. Such controls may, therefore, interfere with the capacity of the private sector to raise capital abroad, the scope to upgrade the domestic financial system through foreign direct investment, and the liberalization of crossborder trade in financial services. In addition, the low rates of return associated with direct controls, together with uncompetitive financial markets, may encourage capital flight.

Fifth, direct controls create various administrative problems and provide opportunities for “rent seeking” and abuse, such as with the allocation of individual bank credit ceilings. Governments may have difficulty ensuring that credit is used for the productive purposes intended under selective credit and interest rate controls.

The implicit tax imposed on commercial banks, and by default their borrowers and depositors, by credit ceilings, interest rate controls, and high non-interest-bearing reserve requirements, encourages the emergence of other, unregulated, financial intermediaries and instruments that compete with the regulated ones. This weakens monetary control by eroding the effectiveness of the direct controls and may prompt the authorities to bear down even harder on regulated financial institutions to achieve a given restrictive policy stance. Unregulated institutions are by their nature less supervised and more prone to solvency and liquidity problems than regulated institutions and may, therefore, also pose a threat to a financial system’s stability.

Alternative Market-Related Monetary Control Framework

A market-based approach to monetary control can be described by distinguishing between the instruments, intermediate targets, and ultimate objectives of monetary policy. The instruments of monetary policy are variables, such as money market interest rates or the level of money market liquidity, which are directly under the control of the monetary authorities, and which influence the path of the intermediate target variables or the final objectives. The intermediate targets are variables, such as various monetary aggregates, that are related in a reasonably predictable manner to ultimate policy objectives—for instance, inflation and nominal GDP. Under an indirect approach to monetary control, the authorities set the instruments consistent with meeting the path for the intermediate targets/objective variables and leave market mechanisms to determine the detailed structure of deposit and lending rates and the allocation of credit.4 In a liberal system, the main instrument of monetary control would be the central bank’s control over interest rates in the money market through its ability to manage its own balance sheet and the stock of reserve money (cash and balances with the central bank). Money market rates, in turn, affect other lending and deposit rates. Such a system does not rely on high or even compulsory reserve or liquid asset requirements, but only on the central bank’s ability to manage its balance sheet, particularly the level of bank reserves, and to control the terms at which it is willing to provide assistance to cover reserve shortages.

Market-based procedures have for several years been the main instrument for conducting monetary policy in the industrial countries with developed money and interbank markets. Such procedures have also assumed a larger role in many developing countries with the aim of increasing the flexibility with which monetary policy can be implemented and eliminating impediments to competition and financial market development. These reforms have become more pressing with the increasing volume and freedom of capital movements. Generally, the reforms have involved the redesign of central bank lending facilities and reserve requirements, development of market-based monetary operations, and fostering of supporting money market institutions and payment system arrangements, as needed.

Among the industrial countries, central bank lending facilities aim predominantly at providing credit to meet technical reserve needs, such as clearing short-term payment imbalances and lender-of-last-resort support, but have also included certain specialized lending facilities intended to promote lending to priority sectors. Table 2.1 provides an overview of the main features of the monetary control instruments that have been applied in Group of Ten countries and Switzerland, and proposed for the European Central Bank.5

Table 2.1.Monetary Policy Instruments in the Group of Ten Countries, Switzerland, and the European Central Bank
BelgiumCanadaFranceGermanyItalyJapanNetherlandsSwedenSwitzerlandUnited KingdomUnited statesEuropean Central Bank
Central bank lending and deposit facilities
Ordinary discount facility available
Loan or advance facility available
Access subject to quotas or ceilings
Penalty for frequent recourse
Key official rate above market rates
Official rate set in relation to treasury bill rate
Deposit facilities
Market operations
Outright market transactions
Purchases of government
securities
Sales of government securities
Purchases of treasury bills
Sales of treasury bills
Purchases of private bills
Sales of private bills
Sales of bills issued by central bank
Reversed transactions
Purchase and resale operations in government securities
Sale and repurchase operations in government securities
Purchase and resale operations in private bills
Sale and repurchase operations in private bills
Foreign currency operations/swaps
Transfer of government deposits
Reserve requirements
Cash reserve requirements in force
Averaging provisions for reserve holding
Carry-over allowed for reserve surplus/deficits
Contemporaneous (C), lagged (L) or semi-lagged (SL)LSLSLLSLLSLL
Length of reserve holding period (in days)3030303030301430
Highest reserve ratio for demand deposits015151.32.5102
Highest reserve ratio for term and saving deposits00.52151.22.502
Penalty for reserve deficiencies (percent above discount rate)3353.55

The supply of bank reserves through central bank standing facilities tended to be demand determined at the discretion of commercial banks (or other eligible institutions), with central bank loans extended at a posted interest rate. Many central banks viewed such procedures as cumbersome, however, providing insufficient flexibility in monetary control. Hence, the trend has been toward curbing automatic access to central bank lending by introducing bank-specific ceilings on such access and penalty rates on extended credit, and by adopting marketbased procedures. Special credit facilities have generally been reduced in favor of a generalized, lender-of-last-resort window against collateral, with day-to-day liquidity management through market-based operations undertaken at the discretion of the central bank.

Market-based monetary operations include outright transactions in bills and other securities, various types of reversed transactions (such as repurchase agreements in bills and bonds and foreign exchange swaps), and transfers of government deposits between the central bank and commercial banks. Outright transactions in securities in secondary markets have tended to be less important than types of reversed transactions. Reversed transactions consist of a purchase or sale of a security (or foreign exchange) combined with an agreement for its repurchase or resale at a specified price and at a given future date. In the United States, the Federal Reserve has been able to use an already existing private market in repurchase agreements; in other countries, special tender arrangements have been set up by the central bank. Reversed security transactions through tenders generally give the central bank substantial scope for setting the price, amount, and maturity. Transfers of government deposits between the central bank and commercial banks are conceptually one of the simplest procedures for managing bank reserves. The procedure, however, raises practical questions—such as the distribution between banks, remuneration, and collateral requirements. It has long been the major instrument for shorter-term monetary management in Canada.

In recent years, variations in reserve requirements have lost importance in the conduct of monetary policy in industrial countries, being replaced to a large extent by the instruments described above. The need to meet legal reserve requirements, however, has remained the fulcrum of monetary policy. There has been a general tendency toward lower reserve requirements, reflecting a concern that high noninterest-bearing reserve requirements encourage disintermediation. To smooth the functioning of the reserve requirement system, several countries have adopted averaging procedures for meeting reserve requirements, designed to give banks more flexibility in their reserve management and to avoid unintended short-term swings in interest rates.6 Industrial countries have generally abandoned the use of liquid asset ratios as monetary instruments and modified the design of such ratios as instruments to emphasize prudential aspects.

A Market-Based System for Underdeveloped Financial Markets

Primary Bill Market Operations

A first step in developing market-based instruments of monetary control in countries with underdeveloped financial markets has frequently been primary issues of treasury bills and/or central bank bills, supported by a restructuring of central bank rediscount windows to allow a greater role for market forces. Commercial banks are often already required to hold treasury bills to meet liquid asset requirements, and, therefore, issues of such paper, which involve less risk than longer-term securities, are a convenient starting point. Issues of central bank securities have been considered useful in some circumstances, because of the potentially greater freedom for the central bank to tailor issues of its own papers to achieve monetary objectives. Although the net budgetary and monetary impact from using central bank rather than treasury paper would in principle be similar, the payment of interest by the central bank on its own debt could affect its profit and loss position, and this could have a monetary effect depending upon the legal and technical arrangements to distribute central bank profits and cover losses, if any.7 In those countries where central bank refinance has been a major source of credit to the banking systems, auctions of the refinance credit have been used to introduce market forces into the allocation procedures. Unlike auctions of bills, however, auctions of credit involve issues of moral hazard and adverse selection, and hence require a careful design to limit these problems as well as measures to reduce the extent of reliance on central bank refinance.8 It is generally desirable to move quickly away from a situation of significant central bank refinance.

The role of security issues as instruments of monetary control is illustrated in Appendix I, using financial flow and balance sheet equations.9 Essentially, the technique is to sell a net volume of securities (e.g., treasury bills or central bank bills) outside the central bank in order to meet an objective for banks’ excess cash reserves. This objective is the short-run operating target of monetary operations. The net volume to be sold is determined on the basis of monetary policy objectives and a forecast of the supply of reserves, compared with the estimate of the banking systems’ demand for reserves. Given these forecasts, the net sales of securities can be targeted to tighten, ease, or maintain the liquidity situation (i.e., raise, lower, or maintain the level of interest rates).

For the central bank to implement the new monetary policy operating framework, a monetary programming procedure must be established to carry out the projections and determine the volume of bills to be sold. The type of operational framework that may need to be developed for determining the regular auction amounts and the volume of money market intervention to be undertaken by the central bank between auctions are illustrated in Table 2.2.

Table 2.2Framework for Regular Forecasting and Daily Monitoring of Cash Positions
VariableRegular Forecast for AuctionFor Money Market Intervention
Commercial banks’ required cash balancesBased on projected growth of monetary aggregates developed by central bank as part of macroeconomic policy framework and analysis of seasonal pattern in deposits of commercial banks.Monitoring unit to prepare assessment of progress under the cash reserve ratios and discuss with banks the level of their desired precautionary cash balances.
Foreign exchangeBased on projections of the balance of payments developed by the central bank and analysis of seasonal pattern in payment flows and intervention by the central bank.Actual intervention by the central bank to be communicated daily to the monitoring unit. Forecast based on two-day delay in settling international transactions.
Currency outside banksBased on currency demand estimates; seasonal patterns; and statistical forecasting techniques.The currency issue to be notified daily to the monitoring unit.
Government accountsForecasts of regular receipts and payments, such as customs duties, and wage and social security payments to be prepared by the relevant government departments. General Accountant to notify of large irregular payments expected during forecast period. List of securities outstanding with amounts and maturity dates and notification of new issues with dates and amounts to be made available to the public.Actual receipts and payments through government accounts to be notified to the monitoring unit. Request forecasts and information from government departments.
Maturing central bank bonds and assistanceLists of bonds and assistance outstanding with amounts and maturity dates.Actual repayments to be notified to the monitoring unit.
Central bank current transactionsCentral bank staff to prepare weekly forecasts.Actual payments and receipts to be communicated to the monitoring unit.
Other central bank current accountsActual balances in accounts to be communicated to the monitoring unit.

Selling techniques for primary bill issues range from “free” auctions to fixed-price tenders. Under “free” auctions, the ministry of finance or, typically, the central bank acting as the agent of the ministry announces the volume of bills to be sold and asks for competitive bids. Interest rates would be allowed to adjust to sell the quantity of bills tendered, and, hence, achieve the targeted stock of reserves. Bills are allocated starting with the highest bid price and moving to the next highest until the tender is fully sold. The auction produces a range of interest rates, with the highest rate determined by the marginal bid that exhausts the tender—known as the “cutoff” or “striking” rate. Bills could be allocated either at the cutoff rate or at the price bid by each successful bidder. Under a fixed-price tender, the central bank sets the interest rate on bills and accepts the volume demanded at that rate, typically during a fixed subscription period. Thus in contrast to the “free auction,” the interest rate is determined in the short run, and quantities are allowed to vary. The interest rate in a fixed-price tender may be varied from one tender to the next to exercise the desired quantitative control.

In introducing primary bill auctions, a concern expressed by central banks about a “free” auction is that it may result in excessive volatility in interest rates, while the concern with a fixed-price tender is that it may risk a “bias to delay” in adjusting interest rates. Central banks have thus adopted different selling procedures that seek to avoid excessive interest rate volatility while allowing flexibility in interest rate adjustment. In some cases, bills are auctioned, but no tender volume is announced in advance. Usually the ministry of finance or the central bank exercises its discretion in accepting or rejecting bids, depending on its quantitative or interest rate objectives. The decision not to announce the tender amount can thus give the authorities added flexibility, although at the cost of reducing information to market participants. In some other cases, bills are auctioned and tender volumes announced in advance, and a permissible range is announced for acceptable bids; the range is usually based on the interest rate set at the previous auction. In some countries the central bank or other financial institutions underwrite the bill issue at interest rates indicated by and agreed with the ministry of finance. Another procedure is for the ministry of finance or the central bank to preannounce an initial auction amount, but to vary it once bids are received in order to achieve interest rate objectives. The central bank may also decide to reject all bids if they are not considered satisfactory. The increased flexibility provided by these various techniques can help overcome initial concerns about a loss of control over interest rates when implementing new monetary control and debt management procedures.

Central Bank Facilities

In addition to issuing primary bills, the central bank may need to intervene to manage short-term fluctuations in liquidity.10 For example, unanticipated deposit withdrawals into cash may be such as to create a reserve shortage and force commercial banks to borrow from the central bank. If not offset by the central bank, the resulting reserve shortages or surpluses could result in excessive volatility in interest rates, complicate banks’ compliance with legal reserve requirements, and interfere with the functioning of the payment system.

Under a strict monetary base control system or regimes that allow for period averaging when determining compliance with compulsory reserve requirements, it is conceivable that banks’ precautionary reserve holdings would remove the need for frequent money market interventions by the central bank.11 Nevertheless, most central banks have facilities for day-to-day money market operations, and the arrangements for such facilities have varied depending on local circumstances and the stage of development of the domestic money market.

Central banks have frequently set penalty interest rates (discount or bank rate) at which they are willing to lend to commercial banks, usually against collateral.12 A loan window provides a facility only to eliminate reserve shortages, and has sometimes been combined with a deposit facility at the central bank to help manage surpluses in liquidity; the European Central Bank has such a facility. The loan window rate has sometimes come to be viewed as the indicative rate for all interest rates, thus inhibiting their market determination. Some countries have sought to mitigate this concern by providing graduated access to the loan window at progressively higher penalty rates.13 A few countries with underdeveloped financial markets have found it useful for the central bank to preannounce its willingness to buy or sell bills at posted interest rates close to those determined in the last primary auction. Such procedures, however, can interfere with monetary control objectives and the development of secondary markets. To reduce these risks, central banks have widened the margins between their preannounced buying and selling rates for bills.

In view of the drawbacks of the above-mentioned techniques, the generally preferred procedure for short-term liquidity management is for the central bank to take the initiative on the quantity of intervention and leave the interest rates to the market. The central bank could participate in the interbank market or conduct auctions of its money market intervention instruments, including outright sales and purchases of specified securities, repurchase agreements, foreign exchange swaps, and rediscounts.14 By restricting these auctions to a few key money market participants, the day-to-day auctions can be implemented more flexibly than the general auctions of primary bills.15 Various techniques can be used to help identify the need for and the volume of such auctions.16

Transitional Considerations in Moving to a Market-Based System

The introduction of more market-based monetary controls raises a number of transitional issues. The transition to full reliance on indirect monetary controls may take time, because experience and confidence in the new system has to be gained by the central bank and the private sector, and new institutional arrangements may have to be established to ensure effective monetary control and competitive market mechanisms. A phased approach to reform may, therefore, be appropriate. If the initial financial system is highly regulated, however, with each regulation supporting the other, it may be difficult to implement a gradual, effective reform. In such cases, a major one-step change in the monetary operations system supported by a critical mass of concomitant reforms of institutions and structures may be unavoidable.

An indirect, market-based approach relies on reasonable efficiency in the monetary transmission mechanism; however, prolonged periods of financial repression usually weaken this mechanism. First, repressed financial systems usually lack competition. While a monopolistic structure may not necessarily interfere with monetary control, it could result in a sluggish response of deposit and lending rates to monetary policy initiatives, inhibit the development of new instruments and markets, and result in an inefficient allocation of resources. The removal of direct controls can itself reduce incentives for monopolistic pricing arrangements by increasing the areas where competition is possible.

Second, repressed financial systems often feature a high incidence of lack of credit discipline and loan delinquency, or arrangements where borrowers or banks expect to have their deficit covered by the government. Such features undermine the role of markets in the allocation of credit. The financial reforms can also bring to the fore weaknesses in bank solvency and in the supervisory arrangements, and can have widespread effects on the viability of borrowers. For example, as the direct controls on interest rates and credit are relaxed, some borrowers that previously had access to directed credit may no longer be viable, and loans will have to be provisioned and written off. Strengthening bankruptcy laws, implementing legal procedures for loan recovery, increasing attention to the quality of bank balance sheets through improved bank supervision, and carrying out bank closures and restructuring may have to accompany the reforms of monetary control procedures. This aspect of reforms is further discussed in Chapter 4.

Third, the effective use of issues of government or central bank securities to manage liquidity will require elimination of captive markets for government securities and the liberalization of interest rates on these securities. These developments could have a direct budgetary impact and call for appropriate institutional arrangements to coordinate monetary and public debt management. But they could also improve the capacity to finance the fiscal deficit, because of the scope for the development of markets in government debt instruments and improved overall savings mobilization. Moreover, under financial repression the actual fiscal burden is often hidden by the below market rates of interest on government debt. These “hidden” deficits still impose a financial burden on the economy, including through low savings mobilization, inefficient allocation of credit, and capital flight.17

Fourth, the transition to indirect monetary controls also raises questions about the selection of appropriate monetary target variables and the interpretation of monetary indicators more generally as guides to policy. Relationships between money and credit and final objectives that existed during the prereform phase may become less reliable following financial reform. The introduction of new instruments may shift the interest sensitivity of money demand. A liberalization of interest rates on bank deposits may result in broad money becoming less sensitive to changes in the general level of interest rates. The removal of credit ceilings that constrain portfolio allocation can result in portfolio shifts, and the liberalization of interest rates can reduce cash holdings by the public.

Not only can the monetary relationships shift, but the controllability of certain aggregates may become more difficult following financial reform. In a liberal environment, the impact of a change in interest rates on broad money and credit will depend on the response of financial institutions in adjusting their rates, and on the portfolio responses of individuals and firms. Initially there is likely to be a good deal of uncertainty about these responses. A range of indicators, including the exchange rate, inflation, and asset prices, as well as various monetary and credit aggregates, therefore, may need to be examined to assess monetary conditions. It may also become more difficult to formulate monetary and credit targets that can act as benchmarks in macroeconomic adjustment programs when structural changes are occurring in the financial system. Nevertheless, quantitative monetary or credit targets often remain a central element in macroeconomic policy formulation.18

As part of a more gradualist approach to reform, interest rates could be set free in stages, for example, by gradually widening the permissible ranges for deposit and lending rates, or by steadily adjusting minimum deposit rates and maximum lending rates, freeing up commercial bank lending and deposit rates from official interference, or removing credit subceilings. The traditional instruments—reserve requirements and rediscount windows—could be deployed initially to manage bank reserves and thereby the credit-creating capacity of the banking system, while phasing out credit ceilings on banks. Market-based instruments of monetary policy would be introduced as the reforms proceed, to manage interest rates and credit more flexibly. The eventual elimination of direct controls would require that the indirect instruments of monetary policy be already functioning in parallel. By this stage, progress should also have been made on developing a money market and a more competitive financial system.

The particular phasing of reforms would depend upon the institutional circumstances. For example, if reserve requirements are already at high levels, and are nonremunerative, it would be undesirable to increase them further; market-based instruments of greater flexibility should be developed at an early stage in the reform process. If the major source of liquidity and credit creation is preferential refinance credit, the initial focus should be on reducing such credit and applying market interest rates to remaining credit facilities—for example, by auctioning the credit. The parallel development of interbank markets and secondary markets and the supporting payment system may need to be encouraged through appropriate reforms.

Developing Market-Based Procedures of Monetary Control in Nine Developing Countries

This section reviews the use of market-based procedures of monetary control in nine developing countries—Argentina, Brazil, Indonesia, Kenya, Malaysia, Mexico, the Philippines, Sri Lanka, and Thailand—all of which have reduced or abolished the use of direct controls on interest rates and credit, and increased reliance on market-based monetary control. Some of the countries, including Argentina, Brazil, and Indonesia, have for a number of years operated market-based instruments of monetary control, although direct regulations of interest rates and credit have been retained or reintroduced to a certain degree. Other countries have undertaken quite determined reductions in direct controls more recently.

Reforming Monetary Instruments

The approaches to market-based procedures for monetary control followed by these countries are summarized in Table 2.3. Appendix II provides more detailed information on the approaches to monetary control. The main conclusions emerging from the country experiences are:

Table 2.3.Development of Market-Based Procedures for Monetary Control in Nine Developing Countries
CountryPrimary Issues of Securities and Other Market-Based InstrumentsTargets of Security IssuesInstruments of Daily Money Market ManagementOther Monetary Instruments and ControlsIntermediate and Short-Term Operating Targets
Argentina (July 85-March 91)Weekly auctions of participation in government papers in the form of central bank bills.Volumes sold to meet quantity objectives; however, volume targets overridden to limit volatility in interest rates.Repurchase/reverse repurchases, foreign exchange swaps at interest rates set by the central bank.Interest rate regulations. Quotas on nonregulated rate deposits, acceptances and swaps. Subsidized refinance facilities. Reserve requirements varied actively.Intermediate: Monetary aggregates; at times the exchange rate. Short term: Interest rates on central bank bills or debt sales.
BrazilWeekly auctions of central bank bills (and treasury bills, but mainly for budgetary finance).Volumes preannounced to control money market liquidity; discounts market determined. Prior to 1986, central bank intervened in the treasury bill auctions when bids were unacceptable.Volumes preannounced to control money market liquidity; discounts market determined. Prior to 1986, central bank intervened in the treasury bill auctions when bids were unacceptable.Selective credit controls; subsidized facilities.Intermediate: Monetary aggregates; real interest rates. Short term: Base money, overnight interest rates.
IndonesiaAuctions of central bank bills. The frequency of auctions has varied between daily and weekly.Prior to 1987, cutoff interest rate in the auctions determined consistent with exchange rate objective; subsequently a greater focus on liquidity conditions and interest rates increasingly market determined.Repurchase agreements and daily auctions of central bank bills. Passive central bank accommodation at posted interest rates discontinued, July 1987.Subsidized refinance facilities. Transfers of government deposits. Limits on borrowing abroad.Intermediate: Monetary aggregates and monetary base. Short term: Exchange rate, interest rate.
KenyaWeekly auction of treasury bills.Mainly government finance purposes; monetary objectives targeted 1993- mid-1994.Foreign exchange intervention; open market operations in treasury bills.Reserve requirements varied actively.Intermediate: Monetary aggregates; at times exchange rate.

Short term: Reserve money; net domestic assets of the central bank.
MalaysiaWeekly auctions of treasury bills.Government finance purposes.Discount window, outright sales and purchases of government securities, repurchase/ reverse repurchases, foreign exchange swaps, recycling of government deposits.Selective credit and interest rate controls; reserve requirements varied actively; subsidized refinance facilities.Intermediate: Broad monetary aggregates. Short term: Interbank interest rates.
MexicoWeekly auctions of treasury certificates.Budgetary and monetary objectives. Interest rates freely determined, central bank may intervene to moderate interest rate movements.Outright sales and purchases and repurchase/reverse repurchases. Weekly auctions of fixed deposits and placements from the central bank.Reserve requirements and liquid asset ratios (credit ceilings removed in 1988/89).Intermediate: Exchange rate; growth of central bank credit. Short term: Interest rates.
PhilippinesWeekly auctions of treasury bills, issues of central bank bills.Tender volumes decided based on budgetary needs and increasingly monetary objectives; interest rates determined within a range based on previous auction rate.Repurchase/reverse repurchases, foreign exchange swaps.Reserve requirements varied actively.Intermediate: Base money. Short term: Money market liquidity, interest rates, exchange rate.
Sri LankaWeekly or more frequent auctions of treasury bills; auctions of central bank securities.Volumes of treasury bills based on budgetary, needs cutoff interest rate set by central bank. Sales of central bank securities based on monetary objectives.Repurchase/reverse repurchases, foreign exchange swaps. Secondary window for sale and purchase of treasury bills.Reserve requirements varied actively. Indicative bank by bank credit ceilings. Subsidized refinance facilities.Intermediate: Base money. Short term: Central bank net domestic assets.
ThailandWeekly auctions of treasury bills; central bank bonds.Sales of treasury bills for budgetary purposes and to meet liquid asset requirements; sales of central bank bonds for monetary purposes.Repurchase/reverse repurchases, using government bonds; discount window; forward exchange swaps.Interest rate ceilings gradually eliminated. Subsidized refinance facilities. Guidance on commercial bank lending. Limits on lending spreads.Intermediate: Multiple monetary and credit aggregates. Short term: Interest rates, money market liquidity.

(1) Market-based approaches to monetary control have usually been adopted in the context of progressive modifications of existing monetary instruments. Most of the countries continued to rely to a greater or lesser extent on reserve requirements, liquid asset ratios, and subsidized refinance facilities while increasing the reliance on market-based procedures for monetary and interest rate control. Also, although interest rate controls were relaxed significantly, they were not eliminated completely in a few cases, partly because of concern over the competitiveness of the banking system.19 Although specific credit ceilings were eliminated, guidance on lending was retained in some cases. Countries further along in the reform process, however, have been able to abandon the direct forms of control and to rely on indirect procedures.

(2) Nearly all of the countries surveyed made use of regular auctions—either for central bank or treasury bills—as part of a market-development, debt-management, or monetary-control strategy. Under these auctions, the public submits bids indicating the volume demanded and the bid price to the central bank for treasury/central bank bills on auction. The type of instrument used and the frequency of the auction varied. Typically, the papers used for monetary control through auctions have been short term, with maturities from 7 days to 12 months. In some cases, an inflationary environment has put downward pressure on maturities (Argentina, Mexico, the Philippines, and Sri Lanka). Auctions have normally been held weekly, although the frequency has varied and even daily auctions have been held in one country (Indonesia). Mexico has also held weekly auctions of central bank offers to place or accept deposits to supplement the auctions of treasury bills. Some countries (Mexico and the Philippines) have instituted formal limitations on the cutoff yield in the auctions, in order to promote orderly bidding and to avoid large short-run fluctuations in interest rates. In some countries, participation in the auctions has been formally restricted to financial institutions (Indonesia) or appointed dealers in the papers in question (Mexico and the Philippines). Appointed dealers have sometimes been obliged to make secondary markets in these papers (Philippines).

(3) The objectives and procedures for determining auction volumes and interest rates varied across the countries. In Brazil, Malaysia, Sri Lanka, and Thailand the auction volumes of treasury bills have been determined purely by budgetary considerations. Nevertheless, the central bank has intervened in these auctions, to determine the cutoff rate (Sri Lanka), influence money market liquidity, or moderate the movement in interest rates. In some of the other countries, both budgetary and monetary considerations have been taken into account in determining auction volumes. For example, in the Philippines, the tender volumes of treasury bills have been used to sterilize foreign capital inflows.

Central bank securities have been issued for monetary control purposes, either as a supplement to the issues of treasury bills (Brazil, Philippines, Sri Lanka, and Thailand) or as the primary instrument (Argentina and Indonesia).20 The central bank accepts or rejects bids on the basis of a cutoff yield determined to be consistent with their desired operating target for monetary policy. The most widely used operating target has been short-term interest rates. Other operating targets have included various measures of liquidity (Argentina, Brazil, and Mexico) and net domestic assets of the central bank (Sri Lanka and Kenya).

(4) Day-to-day money-market operating procedures have varied among the countries, but in most such operations have taken on increasing importance as instruments of liquidity and interest rate management. The most common instrument has been repurchase and reverse repurchase agreements using government papers (Argentina, Brazil, Malaysia, Mexico, the Philippines, Sri Lanka, and Thailand). Some countries, such as Malaysia (initially), Sri Lanka, and Kenya, have operated a secondary window for the purchase and sale of treasury bills with interest rates set based on those determined at the latest auction rate. These interest rate margins have been varied to encourage secondary sales or purchases, which help to achieve objectives for money market liquidity. Several countries have operated a loan or rediscount window carrying varying degrees of penalty (for example, Kenya); and some countries have used foreign exchange swaps (the Philippines and Argentina). Interest rates on most of these facilities are determined by the central bank. Malaysia and Indonesia have supplemented these facilities by the transfer of government or public enterprise deposits between the central bank and commercial banks as a way of managing money market liquidity. Some countries (most notably Indonesia and the Philippines) have also reformed the central bank’s refinance facilities for priority sector borrowing to, among other things, restrict the financial institutions’ access to central bank credit and to rationalize rediscount facilities.

(5) Countries that have taken the most determined steps toward a market-based monetary control system adopted their intermediate targets for monetary policy sometimes in the context of a modification of their exchange arrangements. Following its financial reform, Indonesia changed from targeting domestic credit of the banking system to targeting base money and broad money. In Malaysia and Sri Lanka, the focus shifted from interest rates to broader monetary aggregates. Also, the Philippines shifted from targeting net domestic assets to targeting base money following the move to a floating exchange rate in late 1984. At different times, the exchange rate has also been used as a key target in some of these countries, including Kenya. Domestic monetary instruments and exchange market intervention have been used to target the rate. The short-term operating targets have most commonly included money market interest rates. In some cases the exchange rate, money market liquidity, and the net domestic assets of the central bank have been used.

(6) In nearly all the countries surveyed, the introduction of market-based instruments was accompanied by measures to foster money and interbank markets, particularly secondary markets in government securities. Country experiences also revealed the complex two-way interactions between choice of monetary instruments and operating procedures, and the characteristics and pace of development of money and securities markets, including the supporting clearing and settlement system for payments. For example, in both the Philippines and Malaysia, the authorities facilitated money market development by adopting market-based instruments. The effectiveness of the instruments was strengthened in turn by the authorities’ efforts to develop money and interbank markets. Their efforts consisted of fostering money market intermediaries, including primary dealer arrangements, rationalizing reserve requirement systems and refinance facilities, and promoting adequate institutional arrangements for coordination of monetary and public debt management.

In some countries, reforms of clearing and settlement systems for payments also helped to strengthen the functioning of money and interbank markets (e.g., Malaysia). Country experiences confirm that aspects of the payment system could play a crucial role in the reform of monetary policy implementation and the pace of development of money markets. For example, lags in the settlement of money and exchange market transactions, accounting rules governing clearing and settlement in central bank books, the level of communications technology, and availability and terms of central bank credit or access to required revenues for settlement purposes are some of the structural elements that influenced the demand for excess reserves and short-term money market conditions.21

Importance of Market-Based Procedures as Instruments of Monetary Control

The importance of market-based instruments in seven of the sample countries is examined in the tables in Appendix II.22 These tables attempt to identify the “autonomous sources” of reserve money expansion and the use of market-based and other instruments, including reserve requirements, to offset the expansion.23 The autonomous sources include the extent to which the domestic financing requirement of the government has to be met by the central bank, the increase in the net foreign assets of the central bank, and central bank autonomous net lending to commercial banks. Instruments used to reduce liquidity include traditional adjustments to reserve requirements or in central bank refinance facilities, and more market-based procedures, including debt sales and money market operations.

Indonesia

In Indonesia, the major monetary disturbances were associated with instability in the balance of payments, and to a somewhat lesser extent domestic financing of the government budget deficit. Indonesia has relied increasingly on market-based instruments to control liquidity since 1983. Up until 1987, the reserve money effects of the changes in net foreign exchange reserves were largely offset by the central bank’s net claims on the government. Increasing use of open-market-type operations began in 1986, and operations in central bank certificates subsequently became the most important instrument for offsetting the fluctuations in international reserves. The central bank continued to provide substantial liquidity support to banks through 1990; such assistance, however, was reduced sharply thereafter to counter larger foreign inflows. In spite of the increased use of market-based instruments, reserve money growth has fluctuated substantially, reflecting insufficient flexibility in domestic interest rates. Reserve requirements have not been used actively to manage liquidity, even in the face of substantial foreign inflows.

Kenya

In Kenya, the impact of the government’s domestic financing needs on reserve money has been moderated through domestic sales of treasury bills and bonds outside the central bank. Before 1990, monetary policy relied largely on direct interest rate controls and bank-specific credit ceilings. In 1990, the Central Bank of Kenya started to pay increased attention to reserve money management and shifted the focus toward indirect monetary policy. The central bank endeavored to counteract autonomous influences on reserve money through open-market-type operations in treasury bills, and in 1992 and 1993 stepped up its sales of treasury bills in the face of a dramatic increase in the government domestic borrowing requirement. This effort led to very high nominal interest rates relative to international levels, which stimulated large capital inflows, and the growth of reserve money was not contained as intended. The government also became increasingly concerned about the domestic interest costs, which undermined the achievements of the budget deficit target. Therefore, the authorities increased the reserve requirement several times during 1993.

Malaysia

Malaysia has employed a wide range of market-based instruments and also relied on changes in reserve requirements since the early 1980s. Initially, reliance was placed on recycling of government deposits in the interbank market, and on foreign exchange swaps. The central bank also posted bid and offer prices for secondary transactions in government securities and bankers’ acceptances, but captive markets for these instruments limited the scope of market transactions. In 1987, the central bank began to issue its own certificates in response to the need for large absorption operations arising from foreign exchange inflows. Subsequently, direct operations in the interbank market became the most important market-based instrument. During 1989-91, the central bank also resorted to changes in required reserves. Faced with large capital inflows in 1992-93, however, the central bank relied heavily on a range of money market instruments—including recycling pension fund deposits, central bank certificates, and interbank borrowing—to sterilize the impact on reserve money, and the growth of reserve money was generally contained. Thus, the choice of instruments and markets for monetary control was constrained by the insufficient development of government securities markets, reflecting the continued reliance on captive markets.

Mexico

Monetary policy in Mexico has been implemented against the background of large government domestic financing needs and instability in the external position. The auctions of treasury certificates (certificados del tesoro or CETES) have covered only a small percentage of the government’s domestic financing needs, and a substantial share of government net domestic borrowing has been provided by the central bank. Changes in the central bank’s refinance and discount facilities have offset movements in net foreign assets and, more recently, reliance has been placed on open market operations. Mexico also used liquid asset ratios to limit foreign borrowing and to control the proportion of deposits held in government paper and with the Bank of Mexico. Foreign inflows were only partially sterilized, resulting in declining interest rates and a relatively rapid growth of reserve money.

The Philippines

The Philippines has used a range of market-oriented procedures to meet the targets for the growth of base money since the early 1980s, including weekly auctions of short-term treasury bills, issues of central bank bills, and reverse repurchase agreements. Active use of these money market instruments was facilitated by parallel reforms to foster the money markets and securities trading (i.e., establishment of a system of primary dealers), institutional arrangements to coordinate monetary and public debt management, and a rationalization of central bank credit facilities. A large recourse to required reserve ratios in 1989-90 partly reflected the weak profit position of the central bank; however, the central bank also relied heavily on money market instruments to sterilize the foreign exchange inflows in 1991 and 1992. A subsequent restructuring and recapitalization of the central bank in July 1993 allowed a reduction in the required reserve ratio, and permitted the central bank to focus mainly on open market operations in the conduct of its monetary policy.

Sri Lanka

Sri Lanka’s central bank began to auction its own securities in 1984, and such issues were the main instrument of liquidity management until 1987, when a weekly auction of treasury bills became the principal monetary control instrument. The central bank continued to rely on a range of instruments until 1992, when greater emphasis was placed on indirect monetary instruments, including open market operations in treasury bills and central bank securities, in the context of a reserve money program. Monetary policy was complicated by large capital inflows in 1993, which were partly sterilized by the central bank through open market sales of treasury bills and central bank securities, by increases in required reserves, and by reduction in autonomous central bank credit to commercial banks. As a result, growth in reserve money—excluding increases due to required reserves—was contained, while interest rates were maintained at relatively high levels.

Thailand

The primary monetary policy instrument used by Thailand’s central bank, the Bank of Thailand, has been double-sided auctions of repurchase agreements in government bonds. The auctions are organized by the central bank, which acts as the principal to all counterparties and intervenes from time to time in response to auction bids and offers. This instrument has been supplemented in recent times by issuance of central bank bonds (because of a shortage of government bonds given fiscal surpluses), a tightening of commercial bank access to refinance facilities, and changes in the central bank’s rediscount rate. A surge in capital inflows after 1989 was offset by rising treasury deposits at the central bank, associated with an overall reduction in the government’s domestic financing requirement, by issuance of central bank bonds, and by reduction in the Bank of Thailand’s refinancing of banks. Reserve money also grew rapidly, however, as interest rates declined. The central bank also increasingly employed foreign exchange swaps to reduce the domestic liquidity consequences of the foreign inflows (see Chapter 6). Increases in required reserves accounted for a significant part of the recorded increase in reserve money.

Implications of the Use of Indirect Instruments for Monetary and Credit Aggregates

This section examines the impact of a greater reliance on indirect approaches to monetary control on the behavior of monetary and credit aggregates, using regression estimates. Error correction models of the following form were estimated for the demand for currency, broad money, and credit to the private sector:

when:

Δis the first difference operator;
Yis nominal GDP;
Pis the consumer price index;
rdis the domestic deposit rate in the equations for currency and broad money, and the lending rate in the equations for credit to the private sector;
rfis the foreign interest rate, the euro-dollar rate in London; and
uis the stochastic error term.

The regression estimates, reported in the first table in Appendix III, illustrate some of the difficulties of conducting monetary policy in countries with developing financial markets. Although there are some exceptions, the estimated money-and credit-demand equations are generally quite poor. This is particularly the case for the sign and significance of the interest rate responses, with a notable absence of sensitivity of broad money holdings to changes in the domestic interest rate. The response of the demand for currency to interest rates tends to be somewhat more significant. Overall the estimates caution against excessive fine-tuning of monetary operations to meet a specific targeted financial aggregate.

The tests of stability of the aggregates comparing the full sample (1970-92) with those for a prereform subperiod are reported in the second table in Appendix III.24 In the majority of countries, a greater reliance on indirect approaches to monetary control—and by implication reduced reliance on direct credit and interest rate controls—resuited in instability in the determinants of the demand for credit by the private sector. Structural shifts were not seen in either Indonesia or Thailand, and in part this may have reflected these countries’ more gradual approach to the liberalization of bank credit markets.25 Instability in broad money demand was also evident in Malaysia and Kenya following the reforms. Kenya was the only country that showed instability in currency demand. Although caution needs to be exercised in the assessment of all the monetary indicators during the period of financial reform, the tests suggest that the credit aggregates were the most heavily affected by the reforms, and that the demand for broad money was more heavily influenced than the demand for currency. As a consequence, the objectives of monetary policy and the design of financial programs may need to be refocused, and the central bank is likely to have to examine a broader range of financial indicators, including the developments in the central bank’s balance sheet, during reform periods.

Capital Flows

In addition to the need to develop market-based monetary controls in the context of financial sector reforms, the growth of international capital flows has added further urgency and importance to the development of such procedures. This section reviews some of the implications of the increase in capital flows for the design of monetary instruments. Capital flows also impose additional constraints on the capacity of a country to conduct independent monetary and exchange rate policies; the latter issues are briefly discussed below and are examined in Chapter 6.

Constraints Imposed by Capital Flows

A simple but powerful way of seeing the impact of free capital movements on monetary and exchange rate policy is through the covered interest rate parity condition, which is the consequence of arbitrage between short-term domestic and foreign interest rates and the discount on the currency in the forward exchange market. The covered interest rate parity condition can be written as follows:

where

id is the domestic interest; if, the foreign interest rate of the same maturity and Fd, the forward discount for that maturity; es is the rate of exchange (units of domestic currency in terms of a foreign currency) in the spot exchange market; and ef, the forward exchange rate on the date of maturity of the interest rate contracts. Thus, where the foreign interest rate and forward exchange rate are predetermined, a country could determine the domestic interest rate or the spot exchange rate, but not both.26

The initial policy response to strong capital inflows with a pegged exchange rate has usually been to conduct sterilized intervention. Such intervention involves quasi fiscal costs, however, and is generally of limited effectiveness since it serves to keep domestic interest rates high, attracting further capital inflows. Pegged exchange rates have also led in some cases to an underestimation of the risks involved in foreign currency borrowing. Thus, as capital account liberalization has progressed, a number of countries have responded to the increase in capital flows by adopting greater exchange rate flexibility, as a way of reducing shorter-term capital inflows that reflect interest rate differentials. In some cases, exchange rate arrangements have evolved in a progressive manner with the degree of flexibility depending on the size of the capital inflow problem. Such arrangements have included exchange rate bands, crawling bands, managed floats, and free floats.

Some countries have followed strong nominal exchange rate anchors, which has required subordinating monetary policy to the maintenance of these anchors and accepting that interest rates be allowed to adjust in response to the capital movements. Such anchors have helped to reduce reversals in capital flows due to uncertainty about the exchange rate. Since the exchange rate instrument is not available to reduce short-term capital inflows, greater attention has been given to the adequacy of prudential standards, including the management of risks associated with potential currency and maturity mismatches in such circumstances.

Some countries have targeted the exchange rate (and hence monetary) policy to maintain competitiveness, and relied on fiscal consolidation to achieve domestic stabilization and to offset the effects of large capital inflows. But because of the limited short-run flexibility of fiscal policy, the authorities have had to rely on other measures to deal with more volatile capital flows, particularly capital controls. Generally, such controls are effective primarily as temporary measures.

Implications for Monetary Instruments

Increased capital mobility will also have a number of operational implications for the design of monetary policy frameworks and the use of different monetary instruments. In the case of fixed or managed floating exchange rate regimes, the external counterpart of money supply may become more volatile, and the demand for domestically defined monetary aggregates may become more sensitive to international interest rate differentials, and may shift as a result of the external liberalization. As a result, it may be more difficult to identify a monetary aggregate with a sufficiently stable behavior that is capable of anticipating the evolution of other nominal variables in the economy. Capital account liberalization, therefore, reinforces the trend toward the adoption of more eclectic monetary frameworks that is frequently a feature of domestic financial sector reforms, and to giving more weight to exchange rates in monetary assessments.27

High capital mobility alters the effectiveness of different monetary instruments in achieving the objectives of monetary policy. On the one hand, instruments that impose a high cost or administrative constraint on the banks—as is the case with credit or interest rate ceilings or high nonremunerated reserve requirements—may be circumvented more easily by disintermediation through the capital account and, therefore, become less effective. On the other hand, monetary instruments that operate on the overall cost of money or credit in financial markets may be transmitted more rapidly to credit and exchange markets and allow the central bank to influence the decisions of financial institutions and markets that operate in its domestic currency, both locally and internationally. The characteristics of the major monetary instruments and the effects of capital mobility are reviewed in Table 2.4.

Table 2.4.Monetary Instruments and High Capital Mobility
Monetary InstrumentMain CharacteristicsCompatibility and Effectiveness with High Capital Mobility
Reserve requirements with no differentiation between residents/nonresidents, domestic/foreign currencyAims to achieve a combination of different objectives: (1) influence the commercial bank’s demand for reserves and, therefore, enhance predictability of reserve money demand, and influence the growth of domestic credit; (2) contribute to the stabilization of short-term interest rates through the effect of averaging provisions; (3) sterilize excess liquidity; (4) increase the seigniorage when reserves are not remunerated.In the case of nonrenumerated required reserves, high capital mobility and the lack of harmonization between regulations may prompt operators to relocate their transactions aboard. In response, some countries reduced or eliminated the ratio. To preserve the effectiveness of the instrument some countries maintain restrictions on the issue of domestic securities abroad by residents and on the issue of securities locally by nonresidents.
Reserve requirements with differentiation between domestic and foreign currencyUsed to influence liquidity in domestic and foreign currency and to encourage or discourage deposit taking in local and foreign currency. Impact depends on the level and rate of remuneration of the required reserves. Low or zero reserve requirements in foreign currency deposits are a feature of offshore banking centers.Applying different ratios on deposits in domestic and foreign currency could serve to influence capital movements. May substitute for reserve requirements differentiated by residency where residents’ holdings of foreign currency deposits are restricted.
Reserve requirements with differentiation between residents and nonresidentsWith nonremunerated required reserves, which impose a tax on bank intermediation, higher ratio on nonresident deposits compared to resident deposits discourages capital inflows through bank deposits by lowering remuneration for the depositor.Has been used by a number of countries to influence capital movements. To be effective in limiting short-term inflows, this instrument would need to be applied comprehensively to all short-term capital inflows.
Deposit requirements on certain capital flowsThrough its cost effect, a nonremunerated deposit requirement serves to reduce or increase the interest differential between domestic and international rates. In some cases it may be replaced by the payment of flat fee.Similar to reserve requirements that differentiate between residents and nonresidents.
Net open position/position limitsUsed predominantly as a prudential control when defined as a net foreign currency position.In some countries open position limits are defined asymmetrically on resident and nonresident transactions and have been changed frequently with the intention of influencing capital flows.
Statutory liquidity ratiosIntended principally as a prudential measure or to influence the allocation of bank assets by imposing the requirement to hold minimum amounts of specified liquid assets as a percentage of specified liabilities. When used as monetary control instrument it affects the allocation of financial assets.As in prudential measure, helps to manage the risks of short-term capital inflows and potential reversals in such flows.
Minimum (or maximum) portfolio requirementsIntended mainly to affect the allocation of credit rather than overall credit availability. Typically imposes on commercial banks the requirement to hold a minimum or maximum of certain assets (e.g., government securities or loans to priority sectors).In the case of qualifying assets restricted to domestic assets, it can influence capital flows.
Interest rate controlsLimitation on the ability of commercial banks to determine their lending and for deposit rates. Typically abandoned with the move to indirect monetary controls.Becomes ineffective with capital account openings because they will be circumvented through capital flows.
Bank-by-bank credit ceilingsDirectly limits the domestic counterpart of money supply through a rationing of the total credit provided by commercial banks. Typically abandoned with the move to indirect monetary controls.Becomes ineffective with capital account openings, because they will be circumvented through capital flows.
Directed creditAllocates central bank credit to commercial banks mostly to finance priority sectors. Abandoned with move to indirect monetary control.In the case of qualifying assets restricted to domestic assets, it may influence capital flows.
Bank-by-bank rediscount quotasAllocates central bank refinance credit among commercial banks, allowing banks to borrow on demand at the central bank. Rediscount quotas usually only available for resident banks.Increased volatility of money supply due to external actors requires flexibility in central bank’s refinancing operations. The importance of rediscount quotas tends to diminish as the main tool for liquidity management.
Standing facilitiesDeposit and lending central bank facilities used at the initiative of commercial banks. Standing facilities usually only available for resident banks.High capital mobility increases volatility of money supply and requires flexibility in the central bank’s liquidity management. Role of standing facilities tends to diminish as instrument of liquidity management.
Public sector depositsGiven magnitude of daily government flows in and out of banking system, real location of government deposits between the central bank and the commercial banks can be used to offset impact of such flows on short-term liquidity. Public sector deposits usually only available for resident banks.Given the need for flexibility in interest rate management, allocation mechanism needs to ensure equitable distribution among the competing commercial banks based on a market mechanism.
Open market operationsMonetary operation at the initiative of the central bank involving one of the following transactions: (1) buying or selling assets outright; (2) buying or selling assets (including foreign exchange) under a repurchase agreement; and (3) lending or borrowing against underlying assets as collateral through an auction mechanism. The central bank typically deals only in its local market and with resident banks.Becomes the preferred monetary instrument as it allows flexibility for timing and amount of the central bank operations, and for managing interest rates.

While many countries have reduced, and some have phased out the use of reserve requirements in the context of high capital mobility, some still rely on them to influence the supply and demand in the market for bank reserves (bank deposits with the central bank).28 Nonremunerated reserve requirements, however, impose a tax on the banks subject to the reserve requirements and thus encourage disintermediation to financial institutions and markets that are not subject to the reserve requirements. A number of countries have responded to this potential problem either by remunerating the reserve requirements at a rate fairly close to market rates or by reducing or eliminating the reserve requirement ratio.29 However, some countries have retained selected capital controls—for example, on the issue of certificates of deposits locally by nonresident banks to safeguard the effectiveness of their reserve requirements. The expectation is that by limiting foreign banks’ access to a particular instrument, the extent of disintermediation would also be limited.30

Open market operations play a core role for the purpose of steering interest rates, managing the liquidity situation in the market, and signaling the stance of monetary policy with an open capital account. When capital moves freely, the central bank is able to affect the conditions of both the domestic and external markets in its local currency through open market operations. Standing facilities, rediscount quotas, and public sector deposits are frequently used to support open market operations, particularly to guide interest rate movements, and transmit rapidly and clearly the central bank’s message to market participants. Movements toward capital account convertibility, therefore, have been supported with the adoption of indirect monetary controls.

Use of Discriminatory Reserve Requirements

Differential reserve requirements on short-term borrowing from nonresidents are frequently used to reduce capital inflows, or change the composition of these inflows. Such measures are sometimes referred to as “Chile-type” measures because of their adoption by the Chilean authorities in 1991, although they have a long history of use in other countries, such as in Germany during the 1970s.

Non-interest-bearing reserve requirements raise the cost of borrowing through the instruments subject to the requirements. If r is the nonremunerated reserve requirement, and if the nominal foreign interest rate, then the effective cost of foreign borrowing to a resident after the imposition of the reserve requirement, ife, becomes:31

The implementation of the reserve requirements will thus increase the cost of foreign borrowing to residents (or conversely reduce the return on local investments to foreign investors), and therefore, reduce borrowing from abroad.

Over time, it would be expected that the interest rate parity condition would be reestablished. Following the imposition of the differential reserve requirement, the domestic interest rate would be determined by the following revised condition:

Since ife>if, the imposition of the differential reserve requirement would require either that the short-term domestic interest rate rise (id>id) or the forward discount on the currency fall. A drop in the forward discount could come about through a depreciation of the spot exchange rate.32

After the adjustments in the domestic interest rate (or the exchange rate), interest rates would again be constrained by the covered interest rate parity condition (equation 3). The non-interest-bearing reserve requirement on foreign borrowing would introduce a wedge between the domestic and offshore interest rates, and other things being equal, allow the country to have a higher domestic short-term interest rate with a given exchange rate than otherwise. By allowing for higher domestic short-term interest rates, the non-interest-bearing reserve requirement might also encourage a shift to longer-term borrowing by residents, and, in turn, could influence the composition of inflows. The effect on the composition of inflows would depend, however, on the resulting evolution of interest rates along the yield curve.33

If the differential reserve requirement is not applied comprehensively to all short-term sources of foreign capital inflows, it may encourage larger short-term inflows through those instruments that are not subject to the requirement. This could result if the general level of short-term domestic interest rates increases with the tightening of monetary policy that accompanies the introduction of the differential reserve requirement, providing, therefore, greater incentives for short-term flows through foreign instruments not subject to the discriminatory requirement.

Various empirical studies have sought to examine the impact of such instruments on capital flows and have generally concluded that they have a temporary effect, but one that can be eroded quite quickly depending on the scope of the controls and the stage of development of financial markets and instruments. Financial derivatives that restructure one type of financial transaction into another have now become an important means of circumventing such regulations, in addition to the more traditional channels for circumvention through instruments not covered by the regulations. Over time, Chile found it necessary to extend progressively the instruments covered by its reserve requirement to all short-term capital inflows in an attempt to avoid circumvention. The effectiveness of the measures in Germany in the 1970s appeared to depend on whether they extended to corporate borrowing.34

Conclusions

An increasing number of developing countries have begun to operate market-based instruments of monetary policy and use these instruments more actively to achieve macroeconomic policy objectives. The decision to introduce more market-based instruments reflects a number of factors, including: a general desire to liberalize markets and to free them from administrative controls that have tended to inhibit the efficient allocation of resources; the ineffectiveness of direct interest rate and credit controls for macroeconomic management in the face of financial innovations, disintermediation, and large private international capital flows; and the inhibiting effect of direct controls on market development, and, hence, on saving mobilization and investment.

The developing countries in the sample examined are in a transitional stage of monetary reform; direct controls have been substantially abandoned but full-fledged open market systems of monetary control have not yet been established. Nevertheless, most countries have developed the instruments and an operational capacity to manage money market interest rates or reserve money growth through indirect, market-based procedures and have relied increasingly on these instruments to effect monetary control. The introduction of more market-based monetary control procedures has required a modification of operating procedures, the development of information systems, and the introduction of new instruments.

The increase in capital mobility has posed a particular challenge for monetary operations in recent years, generating huge flows that have strained the capacity of fledgling money markets. It has also provided additional impetus for the introduction of market-based monetary instruments. Countries have also responded to these flows by adjusting more traditional instruments such as reserve requirements.

The financial sector reforms and the increase in capital flows have implications for the behavior of financial aggregates and thus for the design of monetary control frameworks. The trend has generally been toward the adoption of more eclectic monetary frameworks involving an examination of a broader range of monetary indicators.

Appendix
Appendix I: Security Issues as Instruments of Monetary Control

The role of security issues as instruments of monetary control can be illustrated using the following basic financial flow and balance sheet equations:35

Government’s total financing requirement, dG,

Financing of the external current account surplus, CA,,

Central bank balance sheet flow,

Commercial bank balance sheet flow,

Change in net financial wealth of the domestic nonbank private sector, dW,

where the subscripts G, CB, NB, and B refer, respectively, to the government, central bank, nonbank private sector, and commercial banks. E is government expenditure; R, government revenue; dT, the treasury bill issue; dS, other government domestic borrowing; dF, the change in net holdings of foreign assets; dC, the change in holdings of cash and reserves with the central bank; dL, the change in net loans by the central bank; dA, the change in loans by commercial banks to the nonbank private sector; and dD, the deposits of the nonbank private sector with commercial banks.

The financial flows identity also requires that private sector net wealth changes through surpluses with other sectors—the government and the foreign sector,

The change in the cash reserve holdings of commercial banks, dCB, can be derived by substituting equations (1) and (2) into (6) and using equations (4) and (5).

The change in bank reserves equals the government’s domestic financing requirement (dG + dFG), plus central bank net intervention in the foreign exchange market, central bank net lending to banks and nonbanks, less sales of treasury bills and other government debt outside the central bank, plus the change in cash holdings of the nonbank private sector.

Equation (7) provides a framework for using the treasury bill issue, or other central bank or government security issues, to control the reserves of the banking system. The procedure would be to develop forecasts for the relevant reserve holding period of the supply and demand for cash reserves. The forecast of supply would depend on the government’s net domestic financing requirement, net foreign exchange market intervention by the central bank (dFCB), net lending by the central bank to the banks and nonbanks (dLNB + dLB) and the change in currency holdings by the nonbank private sector (dCNB). The forecast change in the supply of bank reserves, before a new net issue/net redemption of treasury bills, would be given by:

where * indicates a forecast.

This forecast supply can be compared with a forecast of the change in the demand for cash reserves, dCBD, to determine the net volume of treasury bills that would need to be issued to control the cash reserves of the financial system.

The change in the demand for reserves by the banking system is given by,

where α is the compulsory cash reserve ratio on bank deposits, β is the estimated precautionary reserve holding ratio of banks, and dD* is the change in deposits for the relevant reserve holding period.36 The demand for precautionary reserves would depend on the rules and procedures for reserve holding and interbank clearing, the efficiency of the interbank market and the payment system, the volatility in the reserves of banks due to seasonal and other factors, and the extent to which the central bank stands ready to smooth the reserves of the banking system.37

Combining equations (8) and (9) provides a forecast of the banking system’s reserve deficiency (ifdCBD>dCBS) or excess (ifdCBD>dCBS) compared with desired holdings before a net new issue of treasury bills.38 Given these forecasts, the net new issue of treasury bills can be set to achieve monetary objectives. A neutral monetary policy stance—that is, one that would leave money market rates unchanged—would involve removing the excess reserves of the banking system by selling net a volume of treasury bills outside the central bank equal to the difference between the forecast of the supply of reserves to the banking system and the estimate of the banking system’s demand for reserves (or relieving a forecast reserve shortage by not rolling over maturing bills). A restrictive policy stance designed to raise interest rates would involve the creation of a reserve shortage by selling a volume of bills in excess of the forecast reserve surplus. In this case, assuming the forecasts are accurate, banks would find themselves short of reserves and interbank rates would tend to rise. If the sale of treasury bills reduced the aggregate supply of reserves below reserve requirements, banks would have to seek marginal accommodation from the central bank, and the interest rate at which the central bank provides the assistance would become the key determinant of the overall level of interest rates.39 An expansionary stance would involve selling fewer net bills than the forecast cash surplus. In this case banks would have excess cash reserves that would push interest rates down. Interbank rates would fall, and there would be repayments of the central bank credit. In this framework, the design of rediscount windows is an integral element of reserve and interest rate management.40

Appendix II: The Evolution of Monetary Operations in Nine Developing Countries

Argentina

Prior to July 1985, the Central Bank of Argentina sold government paper through public offering at predetermined interest rates. The central bank also operated a repurchase facility for government paper for commercial banks at a preannounced interest rate set by the central bank. Repurchases were available for periods of 7 to 28 days for a minimum of 25 million pesos. In July 1985, as part of the anti-inflation “austral” plan, the central bank began auctioning central bank bills issued against the central bank’s holdings of government paper; these bills have been named “participations” in the bank’s holdings of government papers. Bidders at the auction had to bid both a price and quantity, and the central bank decided the cutoff volume so as to achieve its monetary objectives. These objectives involved a target for the volume of sales, but it appears that when the achievement of the quantity objective would have resulted in an excessive movement in interest rates, the authorities would override the volume target so as to stabilize interest rates. The central bank provided a repurchase facility for the “participations” and set interest rates for the new facility, which was used to manage short-term fluctuations in liquidity between auctions.

In April 1991, the Argentine Convertibility Plan was introduced in the context of a broader stabilization effort; the plan effectively established a currency board-type arrangement. The central bank retained the power to change reserve requirements and conduct open market operations. Also, the plan allowed a domestic currency issue to be backed by foreign exchange for up to one-third in the form of U.S. dollar-denominated bonds issued by the Argentine Government (effectively allowing central bank financing of the government).

Brazil

In Brazil, monetary instruments and operating procedures have undergone a number of changes in recent years. Nevertheless, the basic monetary policy implementation framework has remained broadly unchanged, including primary auctions of treasury or central bank bills and intervention by the central bank to determine interest rates in the interbank market. Until 1986, the central bank intervened in the auctions when the treasury bill rate determined by the bids would have been unacceptable. Its intervention in the money market included outright sales and purchases of assets from its portfolio, and overnight repurchases at interest rates set by the central bank.

Following the introduction of the anti-inflation cruzado plan in February 1986, the authorities changed their monetary instruments to make them consistent with an anticipated low-inflationary environment. Between May 1986 and December 1987, a central bank bill (Letra do Banco Central or LBC) was issued in maturities of up to one year, at weekly auctions. This bill paid a coupon equal to the average interest rate in the overnight money market in the holding period of the bill, and was sold at a discount determined by competitive bidding at the auction. The amount of bills to be auctioned was preannounced, with the major objective of controlling the trend in the volume of money market liquidity. The overnight rate in the interbank market reflected, among other things, the daily repurchase operations of the central bank. The central bank set its repurchase rate to keep real interest rates in the money market close to zero on average over a month, with the interest rate adjusted to the rate of consumer price inflation recorded in the previous month. The central bank’s repurchase operations were, thus, the key influence on overnight rates and, except for the initial discount on new issues at the auctions, which was normally small, also on the yield on LBCs.

In January 1988 a new instrument, the Letra de Financiamento de Tesoro (LFT), a treasury liability with the same maturity and yield characteristics as the LBC, was introduced to replace the LBC. LFTs have also been auctioned weekly, but unlike the LBCs, primary issues of the LFT have been largely based on budgetary rather than monetary considerations. The central bank has, however, continued to set interest rates and to exercise monetary control through its repurchases and also through outright sales of LFTs from its own portfolio and purchases of new issues of LFTs at the auction. LFTs and LBCs are traded in secondary markets organized around about 20 money brokers. Repurchases were normally confined to transactions between the commercial banks and the central bank.

Indonesia

In 1983, as part of a broader adjustment effort, Indonesia initiated a comprehensive reform of its monetary control system. Before the reforms, the banking sector in Indonesia had been highly regulated and had lacked effective competition. Monetary policy relied on bank-by-bank credit ceilings and direct interest rate controls. Ready access to central bank refinancing for priority lending led to persistent excess liquidity, and the existence of nonbank financial institutions exempted from the direct regulations resulted in disintermediation and monetary substitution.

Indonesia has taken a gradual approach toward reforming its monetary control system. The first stage of monetary reform in 1983 included the removal of direct controls on interest rates and credit, and some curtailment of the central bank’s funding of banks through refinancing of priority sector credits. In 1983-85, new money market instruments—central bank (SBI) and private (SBPU) papers—and an auction system for the SBIs were introduced, and the central bank’s refinancing facilities were further restructured. Two new rediscount facilities were introduced in February 1984, to replace the automatic access that all banks had for refinancing priority credits. The access to the new facilities was limited to “sound” banks, and use was discouraged by the maintenance of a high discount rate and the fact that borrowing was seen as damaging to a bank’s standing. One of the facilities was designed to smooth short-term liquidity shortages in the banking system, while the other was intended to promote long-term lending and assist banks in addressing maturity mismatches.

When the auctions of SBIs were introduced in March 1984, SBI maturities were for 30 and 90 days, but bills with 7-day and 180-day maturities were introduced later.41 The frequency of auctions varied from as often as daily to three times a week to once a week. Only banks and nonbank financial institutions have been allowed to participate, but other entities have been permitted to acquire SBIs in the secondary market. The central bank sets the cutoff yield in the auctions. The SBPUs were introduced in February 1985; these instruments were essentially standardized banker’s acceptances, promoted by the government. In practice, the interest rates on SBPUs have closely followed those of SBIs. To provide liquidity to the SBPU market, the central bank subsequently started rediscounting of SBPUs.

A state-run securities house, FICORINVEST, was created to facilitate trading in SBIs and SBPUs. Initially, FICORINVEST was the market maker in these instruments (it stood ready to buy and sell SBPUs at posted bid and offer prices), and could automatically rediscount them with the central bank at a profit. Also, it would discount SBIs at the interest rate of the original SBI issue without regard to its remaining maturity, and could automatically rediscount them at the central bank, also at the original issue price. The cutoff rate in the auctions and the posted interest rates through FICORINVEST were initially changed infrequently.

In July 1987, the central bank phased out the automatic rediscounting of SBIs and SBPUs, hence discontinuing its passive accommodation at posted interest rates. The main instruments have since been daily auctions of seven-day SBIs and of seven-day repurchase agreements in SBPUs carried out daily, and interest rates set by the central bank, based on bids or offers received.42 The central bank began using the cutoff rate at the SBI auctions as the main operational target. In mid-1987, following a deterioration in the external sector, policy shifted to protecting the net international reserves position of the central bank, and the exchange rate as well as interest rates became more flexible.

Another package of reforms to strengthen monetary control and develop money markets was introduced in late 1988. This package (1) refined the daily money market operations of the central bank by, among other moves, channeling the central bank’s operations through a group of specifically appointed commercial banks and nonbank financial institutions that acted as primary dealers, brokers, and market makers for SBIs; (2) reduced reserve requirements to 2 percent (excess liquidity created by this operation was absorbed by the issuance of short-term SBIs); (3) eliminated limits on interbank borrowing and promoted the use of SBIs for interbank repurchase transactions and liquidity management. These reforms were complemented by the deregulation of the banking system, including relaxation of barriers to entry, and a strengthening of prudential supervision, through improved on-site and off-site inspections and the introduction of a comprehensive system of capital adequacy ratios, bad debt provisions, bank ratings, and accounting principles. The use of market-based monetary instruments in Indonesia in 1983-93 is reviewed in Table 2.5.

Table 2.5Indonesia: Major Factors Affecting Reserve Money(In billions of Indonesian rupiah unless otherwise noted; ended March)
1984198519861987198819891990199119921993
Change in central bank net claims on government−1.475−2,7031,051−1,9791,780772577−5,367−4791,303
Change in net foreign assets of central banks12,1131,513−1,266−2,6303,034−3,0097378,9705,68410,018
Change in autonomous net domestic assets of central bank26701,6801,7241,9065552,0104,247−4,346842−319
Of which: liquidity credits1572,5029541,1751,3202,8994,241−4,390708−335
Change in the use of money market instrument by central bank−457219629−609−1,243189306−1,037−12,144
In percent of reserve money at beginning of period−1.10.13.88.3−7.6−13.62.12.9−9.4−83.0
SBIs (central bank certificates)
Outstanding−45−198−1,1511,233−607−1,6021547,198−1,915−11,681
Rediscounted946−90581
SBPUs (private sector money market papers)
Rediscounted2054173136,7823−2,586−1,577
Other facilities7−12−257−46162−16239
Change in reserve money1,2634971,7214391,1153021,6375603,6261,075
In percent31.09.329.55.814.0−3.318.65.433.37.3
Memorandum:
Money market interest rates (in percent)
Nominal18.610.313.014.515.012.614.415.112.18.7
Real9.25.87.46.76.77.03.46.84.52.7
Sources: Data provided by the Indonesian authorities; and IMF staff estimates.

On a transition basis, excluding valuation changes.

Includes refinance and rediscount facilities, loans to private and public enterprises, and other items.

Includes special SBPUs (private sector money market papers) injected to banks amounting to Rp 6.6 trillion to compensate for the withdrawal of state enterprises’ deposits.

Sources: Data provided by the Indonesian authorities; and IMF staff estimates.

On a transition basis, excluding valuation changes.

Includes refinance and rediscount facilities, loans to private and public enterprises, and other items.

Includes special SBPUs (private sector money market papers) injected to banks amounting to Rp 6.6 trillion to compensate for the withdrawal of state enterprises’ deposits.

Kenya

As part of a medium-term structural adjustment program in the late 1980s, the Kenyan authorities began to move toward a market-oriented system of monetary control, to be based on open market operations. While good progress was made initially in making the monetary policy framework more effective and responsive to market forces, the momentum was temporarily lost in the political and economic turmoil that preceded the first multiparty elections in late 1992.

The tendering of treasury bills began in 1985 and of treasury bonds in 1986. The authorities relaxed their direct credit controls in 1986-87; however, concern about the risk of an excessive credit expansion led them to reimpose ceilings on the growth of bank lending to the nongovernment sector in late 1987. Subsequently, the removal of credit ceilings resumed; credit ceilings were fully abolished by December 1994 when marginal ceilings were eliminated.

Open-market-type operations based on the primary issue of treasury bills were introduced in late 1990; market forces were allowed to determine interest rates, and the amount of bills offered was determined by monetary policy considerations. Also, the central bank acquired treasury bills in the auctions on its own account for later use in open-market operations.

The discount window was restructured in support of these operations. Initially, the discount window was available to any holder of eligible securities at a nonpenal rate, with the rediscount rate set at ⅛ of 1 percent above the treasury bill rate. Subsequently, the discount rate was raised to the treasury bill rate plus 1.5 percent. In 1992, the access was further tightened, and a graduated interest rate, increasing with the level of access, was introduced.

The unsettled situation during the democratization process led to a loss of monetary control in 1992 and early 1993, as several banks gained access to central bank credit through irregular means, and the enforcement of the reserve requirement weakened. Monetary expansion accelerated, and a foreign exchange crisis ensued in March 1993. Also, the weak enforcement of prudential regulations undermined the soundness of the banking system. Subsequently, the authorities took a number of actions to reestablish monetary control and to strengthen the monetary policy framework. These actions included stepped-up issuance of treasury bills, combined with increased flexibility in the interest rates; a series of increases in the reserve requirement; stricter enforcement of the reserve requirement through severe penalties for noncompliance; a streamlining of the settlement procedures for bank clearing to stop unintended access to central bank credit; and further tightening of the access to central bank rediscounting through higher penalty rates and a narrowing of the range of eligible securities. Also, several insolvent banks were closed down.

As the above measures led to very high interest rates, which stimulated capital inflows in late 1993 and in 1994, the authorities relied more on increases in the reserve requirement to sterilize the inflows. This was done to avoid the direct costs to the central government budget of the sterilization operations through treasury bills. The use of market-based instruments in Kenya is reviewed in Table 2.6.

Table 2.6Kenya: Major Factors Affecting Reserve Money(In millions of Kenya shillings; ended December unless otherwise stated)
19831984198519861987198819891990199119921993
Domestic financing of the government deficit11,5773,0333,8256,7838,8833,5862,27410,6016,89817,38124,475
Treasury bills1,9222,5445,3102,471−2,162−132−2,156−2,1063,67751,383
Other securities1512697242,8025,8241,5841,9116,67411,392−14,515
Other2982812−2513,510−7 682210,8462,3302,312−12,393
Uptake of government debt by central bank3−7845999439554,122790−1,5997,8213,969−7,752−3,375
Change in net foreign assets of central bank4884753−721−125−176−1,390707−3,040−3,39020214,049
Change in autonomous net domestic assets of central bank5204−234−4 4246−7211,013−1,0737,0104,6253,8256,568
Change in the use of money market instruments by central bank6−2,162−132−2,156−2,1063,67751,383
In percent of reserve money at beginning of period6−18.6−1.115.6−13.420.4200.0
Change in reserve money−1286459532,8751,961−2312,0923,1512,75610,88916,398
In percent2.211.415.139.619.4−2.117.021.815.753.552.5
Change in required reserves3253473226397928,313
Memorandum:
Money market interest rates (in percent)7
Nominal14.1513.2413.9013.2212.8613.4813.8614.7816.5916.5349.80
Real2.52.80.78.14.82.10.8−0.7−2.7−10.02.7
Sources: Data provided by Kenyan authorities; and IMF staff estimates.

Fiscal year (July-June) basis.

Residual.

Includes treasury certificates used for monetary control purposes.

Includes valuation changes.

Includes refinance and discount facilities.

± indicates withdrawal/injection of liquidity.

Treasury bill rate.

Sources: Data provided by Kenyan authorities; and IMF staff estimates.

Fiscal year (July-June) basis.

Residual.

Includes treasury certificates used for monetary control purposes.

Includes valuation changes.

Includes refinance and discount facilities.

± indicates withdrawal/injection of liquidity.

Treasury bill rate.

Malaysia

The system of monetary control in Malaysia has evolved over time in response to exogenous developments—notably, the increased international capital mobility and the development of the financial system. Under these circumstances, Malaysia has employed a wide range of monetary policy instruments, with the relative reliance on specific instruments varying over time. Thus, the instruments used by the central bank—the Bank Negara Malaysia—have included reserve requirements; liquidity requirements; shifts of central government deposits between the central bank and commercial banks; money market operations; discount facilities; limits on the commercial bank foreign exchange swap transactions; direct interest rate controls; credit controls and lending guidelines; and moral suasion. Over time the instruments have been adapted gradually in support of a more market-oriented monetary policy, however.

Reserve requirements have continued to play an important role in Malaysia’s monetary policy. In particular, in the late 1980s when there was a need for large liquidity withdrawal to neutralize foreign exchange inflows, the central bank raised the reserve ratio several times.43 The reserve requirement has been streamlined; the ratio was unified for commercial banks, finance companies, and merchant banks in May 1989; and averaging provisions were introduced in January 1991 to reduce volatility of interbank interest rates.

The liquidity requirement has been used to create captive markets and meet prudential concerns, and the ratio was adjusted only infrequently. But the definition of eligible liquid assets has been changed several times for a variety of reasons, including to direct credit to the government securities and other priority sectors; to influence the financial institutions’ scope for credit extension; and to secure demand for new money market instruments and Bank Negara bills.

The central bank operates auctions of treasury bills but solely for government finance purposes.44 An effort was made in 1986-89 to develop the secondary markets in government securities so as to increase the scope for open-market operations. This effort included modification of the liquidity requirement to reduce the captive market for government securities, introduction of market-based pricing of such papers, and standardization of the issue amounts for treasury bills. It also included increasing the frequency and reducing the maturities of government securities. Primary dealer arrangements were introduced to foster secondary trading in government- and government-guaranteed securities, supported by reforms of the clearing and settlement system for payments. However, the progressive decline in the government’s domestic borrowing requirement has made it difficult to develop secondary markets in government debt. Other segments of money and interbank markets have developed sufficient depth to support the effectiveness of market-based instruments.

In the absence of well-developed secondary markets for government securities, Malaysia’s central bank has relied on influencing other money market segments, along with shifting government deposits for short-term monetary management—a practice that was intensified in 1990. Faced with considerable excess liquidity as a result of the foreign exchange inflows, government deposits were shifted from commercial banks to the central bank to absorb liquidity. Subsequently, a similar arrangement was put in place for the deposits of the Employees Provident Fund in October 1992. The central bank started issuing bills akin to treasury bills (Bank Negara bills) to absorb liquidity. In addition, the Bank Negara Malaysia has occasionally relied on direct borrowing from and lending to commercial banks in the interbank market. Discount operations traditionally have played only a minor role.45

Limits on foreign exchange swap transactions of commercial banks have been used both to contain foreign exchange outflows (in 1988-89) and to restrain foreign inflows (beginning in June 1992). To limit foreign exchange outflows, the central bank fixed a maximum limit on the offer side of swap transactions, while to limit inflows, the limit was set on the bid side. In both cases, trade-related swaps were excluded from the limits.

Interest rate controls were substantially eliminated in February 1991. Earlier, Bank Negara Malaysia, in consultation with the Association of Banks, stipulated minimum lending rates and maximum deposit rates, partly with the aim of limiting competition in the banking system in order to protect domestic banks. In 1983, this system was replaced with a base lending rate influenced by the central bank, to which all banks were required to peg their own interest rates. In February 1991, the base lending rate was freed from administrative influence by the central bank, as were all other interest rates except those for lending to priority sectors, such as small-scale businesses and housing. Loans to these sectors remained subject to the central bank’s annual lending guidelines.

Malaysia’s central bank has also in some instances maintained direct credit controls to limit lending for certain purposes—notably to curtail consumer spending, particularly for spending financed by credit cards, and for such sundry uses as rental cars. The central bank has also continued to use moral suasion on bank lending policies. These instruments have been aimed at encouraging lending for development and the avoidance of excessive speculation and risk taking. Malaysia’s use of market-based monetary instruments is reviewed in Table 2.7.

Table 2.7Kenya: Major Factors Affecting Reserve Money(In billions of Malaysian ringgit; ended December unless otherwise stated)
1984198519861987198819891990199119921993
Domestic financing of the government deficit1.81.85.08.97.05.44.33.24.52.8
Treasury bills0.21.03.3
Other securities3.13.64.67.57.02.43.93.21.4−0.6
Other1−1.3−1.80.00.4−3.33.00.40.03.13.3
Change in net claims on government by central bank20.9−0.8−0.3−0.40.1−0.6−3.0−1.8−1.12.7
Change in net foreign assets of central bank31.02.43.52.9−1.23.35.33.417.029.2
Change in autonomous net domestic assets of central bank4−3.9−2.32.72.43.0−5.4−0.99.013.4
Of which: refinance and rediscount facilities0.1−0.11.30.1
Change in the use of money market instruments by central bank1.5−1.2−4.7−3.03.61.1−22.9−39.7
In percent of reserve money at beginning of period16.7−12.4−46.4−25.224.36.1−110.1−156.9
Foreign exchange swaps0.60.7−2.2
Recycled government EPF deposits1.0−2.6−1.6−6.7−6.0
Government securities−0.10.7−0.10.71.3−1.1−1.1−1.0
Central bank certificates−0.80.8−6.1
Interbank borrowing−4.52.32.2−15.1−26.6
Change in reserve money0.40.10.50.51.33.33.53.62.72.9
In percent3.77.64.25.211.827.722.919.012.811.6
Change in required reserves50.4−0.1−0.02−0.030.22.22.22.61.81.2
In percent of reserve money at beginning of period4.2−1.6−0.30.31.718.314.413.98.04.9
Memorandum
Money market interest rates (in percent)
Nominal9.07.68.02.93.24.76.87.88.03.3
Real7.97.57.7−0.31.11.73.03.24.53.2
Sources: Data provided by Malaysian authorities; and IMF staff estimates.

Residual.

Includes recycled government deposits and government securities used for monetary control purposes.

On a transaction basis, that is, excluding valuation changes.

Includes refinance and discount facilities, loans to private and public enterprises, and other items.

Includes commercial banks, finance companies, and merchant banks.

Sources: Data provided by Malaysian authorities; and IMF staff estimates.

Residual.

Includes recycled government deposits and government securities used for monetary control purposes.

On a transaction basis, that is, excluding valuation changes.

Includes refinance and discount facilities, loans to private and public enterprises, and other items.

Includes commercial banks, finance companies, and merchant banks.

Mexico

Since 1978, the Central Bank of Mexico has operated weekly auctions of treasury certificates (CETES). From 1982 to 1985 auction amounts were predetermined and interest rates were allowed to reflect market conditions. This system was temporarily suspended and replaced with a fixed-price tender system in late 1985, because of concern over high interest rates; the market-based auction system was reintroduced in July 1986.46 The issuance of CETES over a period of several years contributed to the gradual development of financial markets, and in particular government securities markets. This long-term effort provided a solid basis for the liberalization and introduction of an indirect monetary policy framework in 1988.

CETES have been issued in fixed denominations, with maturities between two and seven years. Participation in the auctions was initially restricted to a group of licensed CETES dealers, but others were allowed to acquire CETES by purchasing them from these dealers. Subsequently, the auctions have been opened to all banks and exchange houses. The interest rate on CETES is freely determined, although the central bank has bought CETES in the auction for subsequent use in its money market operations, aimed at moderating transitory swings in interest rates and in money market liquidity. These operations have included outright sales and repurchase/reverse repurchase agreements. The amount of CETES auctioned each week was in principle to be determined by the financing needs of the Treasury and monetary policy considerations. Because of concerns about the budgetary impact of interest costs, however, the weekly auctions of treasury bills have been supplemented by offers from the central bank to place or accept fixed deposits with the commercial banks (subastas de depósitos). The deposits have typical maturities ranging from 14 to 91 days, and are also auctioned weekly. Only banks are allowed access to these auctions.

Mexico continued to make active use of direct controls on credit and on longer-term interest rates through 1988, and used reserve requirements frequently for monetary control purposes. Under these circumstances, the informal financial sector flourished. But in late 1988, in the context of its broad-based adjustment program, Mexico initiated a series of reforms aimed at altering the financial and monetary control systems in a fundamental manner. Quantitative restrictions on bankers’ acceptances were lifted, followed by the deregulation of interest rates and the removal of restrictions on bank lending, as well as the conversion of the reserve requirement to a liquidity requirement in 1989. The liquidity requirement was abolished altogether in 1991. Starting in 1988, the exchange rate policy was aimed at stabilizing the Mexican peso against the U.S. dollar. Foreign exchange controls were eliminated in late 1991. Two new indexed government debt instruments were introduced in 1989: tesobonos, indexed to the exchange rate; and adjustabonos, indexed to the Consumer Price Index. The above measures were combined with a rapid reprivatization of the banking sector and—to address the problems of insolvent banks—a strengthening of prudential supervision and regulation, including new criteria for rating credit portfolios and capital adequacy.

Following these changes, government securities were the main instrument of monetary policy, both in the primary and the secondary market. As noted above, the Bank of Mexico participates in the weekly CETES auctions, primarily to smooth short-term interest rate movements. The bank intervenes daily in the secondary market, primarily through repurchase agreements and reverse repurchase agreements, rather than through outright sales or purchases. In addition, the Bank of Mexico retains the power to vary reserve requirements and to auction credit, but has generally abstained from making use of these instruments. The bank does not operate a standard discount window, but commercial banks are permitted to run overdrafts on an overnight basis with provisions for next-day settlement.

During the early 1990s, the central bank varied the liquidity coefficient imposed on domestic and foreign currency deposits in order to control the foreign indebtedness of commercial banks, as well as the proportion of deposits that had to be invested in the Bank of Mexico and specific government papers. Subsequently, the Bank of Mexico relied on open-market operations. The importance of market-based monetary instruments in Mexico is reviewed in Table 2.8.

Table 2.8.Mexico: Major Factors Affecting Reserve Money(In billions of Mexican pesos; ended December unless otherwise stated)
19831984198519861987198819891990199119921993
Domestic financing of the government deficit18241,5084,09711,12024,95746,87628,94319,898−30,200−45,250
Treasury certificates (CETES)12.3−861,1493,8368,780−2,5478,4482,86718,395−8,525
Other27011,5942,9487,28416,17749,42320,49517,031−48,595−36,725
Change in net claims on government by central bank31,0689442,1783,93598021,4426,0402,207−19,107−5,819
Change in net foreign assets of central bank4 (millions of new pesos)372569−6263828,231−15,2781,3379,17224,6093,6338,871
Change in autonomous net domestic assets of central bank5,6−501−541,4191,6132,30320,5986,895−3,487−16,009−931−20,7087
Change in the use of money market instruments by central bank8−951−1,158−135−1,100−1,173
In percent of reserve money at beginning of period−156.4−142.3−10.3−54.932.2
Change in reserve money millions of new pesos1,1571,6548272,7385,9586,4722,1388,1238,6625,7384,739
In percent55.951.317.048.070.644.910.235.327.814.410.4
Memorandum:
Money market interest rates (in percent)
Nominal57.549.962.488.495.669.047.437.425.618.917.4
Real17.513.315.831.842.352.326.418.712.29.911.9
Sources: Data provided by Mexican authorities; and IMF staff estimates.

Public sector.

Residual.

Includes CETES used for monetary control purposes.

On a transaction basis, that is, excluding valuation changes.

Includes refinance and discount facilities, loans to private enterprises, and other items.

Effective flows.

January-September.

Fixed deposits with or placements by the central bank.

Sources: Data provided by Mexican authorities; and IMF staff estimates.

Public sector.

Residual.

Includes CETES used for monetary control purposes.

On a transaction basis, that is, excluding valuation changes.

Includes refinance and discount facilities, loans to private enterprises, and other items.

Effective flows.

January-September.

Fixed deposits with or placements by the central bank.

The Philippines

In October 1984, the Philippines authorities reformed their monetary policy framework by floating the Philippine peso and changing the domestic monetary target from the net domestic assets of the monetary authorities to base money.47 Interest rates had been gradually deregulated in the 1980-83 period and have since been freely determined.

The main instrument of short-term monetary control in the Philippines has been a weekly auction, initially of central bank bills with maturities ranging from 30 to 90 days, and beginning in late 1986, of treasury bills issued at maturities of 91, 182, and 364 days (see Ealdama, 1986, for a description of the auction system). By the end of 1987, treasury bill issues had virtually replaced the issues of central bank bills. A proportion of the proceeds from the sale of treasury bills is held by the government in special fixed deposits with the central bank for the explicit purpose of sterilizing liquidity. The regular auctions of short-term paper have been supplemented by auctions of three-year treasury bills. Participation in the auctions has been limited to a group of commercial banks that have been given status as primary dealers based on their financial soundness; bills are to a large extent sold on to nonbanks. The primary dealers are obliged to participate in the auctions, to have bids regularly accepted, to undertake secondary trading in government securities, to post reasonable two-way prices for these securities, and to submit certain market information to the central bank. An Auction Committee, which includes the top-ranking officials of the Ministry of Finance and the central bank, conducts the auction; the Open Market Committee decides the tender amounts, based on the treasury’s financing needs and the monetary policy stance adopted. The cutoff price in the auction usually is linked to the price range accepted in the previous auction, normally so that it deviates by less than 20 to 30 basis points from that auction. At times, this constraint has led to the rejection of all bids. There is also some noncompetitive bidding, limited to 20 percent of the total tender.

For shorter-term monetary control, the auctions have been supplemented by repurchase and reverse repurchase agreements using the bills held in the central banks’s own portfolio. The central bank had made extensive use of foreign exchange swaps until late 1984, when it ceased providing new swap agreements, although existing agreements were rolled over. As a result of the depreciating Philippine peso, the central bank has suffered substantial operating losses on its foreign exchange swaps.

The central bank has restructured its refinance facilities, with the aim of reducing use and rationalizing function. By late 1985, the number of refinance facilities had been reduced from five to a single facility, covering a range of purposes (most outstanding credits have been for export refinancing). The interest rate charged under the single facility has been market based, and is adjusted in line with market rates.

During 1991-92, to sterilize the very large capital inflows, the authorities resorted to large issues of short-term treasury securities through the regular weekly auction and the secondary market, and sold central bank bills and conducted reserve repurchase agreements. Reserve requirements were also raised in 1989 and 1990 to their legal maximum of 25 percent. The scope for central bank open market operations had been constrained by the weak financial position of the central bank. The restructuring and recapitalization of the central bank in July 1993 increased the scope for open-market operations and allowed a reduction in the required reserve ratio. The role of marketbased instruments of monetary control in the Philippines is reviewed in Table 2.9.

Table 2.9Philippines: Major Factors Affecting Reserve Money(In billions of Philippine pesos; ended December unless otherwise stated)
19831984198519861987198819891990199119921993
Domestic financing of the government deficit (PSBR)2.08.111.527.713.519.011.433.119.51.69.4
Treasury bills50.536.721.728.320.9122.577.3
Holding by central bank−0.8−0.127.4144.27
Other securities3.62.7−1.2−21.624.731.363.5
Other1−40.620.4−9.126.4−26.1−152.2−131.4
Change in net claims on government by central bank22.1−0.616.4−7.9−36.0−19.56.12.1−15.7−64.31273.77
Change in net foreign assets of central bank3−20.90.8−1.822.9−5.112.08.9−9.453.344.510.8
Change in autonomous net domestic assets of central bank416.018.970.923.621.016.222.145.114.67.7−307.57
Of which: lending to financial institutions and rediscounts−1.81.62.7−1.42.4−0.30.6)2.1−0.3−4.0−7.1
Change in use of money market instruments by central bank50.2−9.518.32.119.21.03.00.9−50.2−34.642.1
In percent of reserve money at beginning of period1.0−32.9−52.95.537.61.74.51.2−46.1−26.729.1
Change in reserve money9.45.74.612.06.99.625.615.820.715.426.9
In percent47.620.513.831.613.816.638.017.019.011.918.6
Change in required reserves4.31.72.00.82.03.513.919.910.09.79.4
In percent of reserve money at beginning of period21.85.95.82.13.96.120.720.79.27.56.7
Memorandum:
Money market interest rates (in percent)6
Nominal14.228.526.716.111.514.718.623.721.516.012.4
Real−19.39.726.012.53.43.96.27.913.39.00.2
Sources: Data provided by Philippine authorities; and IMF staff estimates.

Residual.

Includes the government’s fixed deposits with the central bank, associated with the issuance of treasury bills.

On a transaction basis, that is, excluding valuation changes.

Includes refinance and discount facilities, loans to private and public enterprises, and other items.

Repurchases/reverse repurchases, operations in central bank papers and treasury securities.

Treasury bill rate.

Reflects restructuring and recapitalization of the central bank, July 1993.

Sources: Data provided by Philippine authorities; and IMF staff estimates.

Residual.

Includes the government’s fixed deposits with the central bank, associated with the issuance of treasury bills.

On a transaction basis, that is, excluding valuation changes.

Includes refinance and discount facilities, loans to private and public enterprises, and other items.

Repurchases/reverse repurchases, operations in central bank papers and treasury securities.

Treasury bill rate.

Reflects restructuring and recapitalization of the central bank, July 1993.

Sri Lanka

Since 1985, the nominal exchange rate for the Sri Lanka rupee has been adjusted regularly to counteract inflation differentials between Sri Lanka and its main trading partners. Within the constraint set by the exchange rate arrangement, the interest rate previously played a major role as the operational target. Since early 1988, the main operational target has been the net domestic assets of the central bank, derived from intermediate targets for monetary and credit aggregates.

Sri Lanka has undertaken several changes in its monetary control system in recent years. The central bank began auctioning its own securities in 1984 and such issues were a main instrument used to manage money market liquidity during 1985 and 1986. Auctions of central bank securities were held about once a month until 1987. Beginning in 1986, many direct credit controls were removed, and the central bank refrained from strict enforcement of the remaining ceilings. Reserve requirements have continued to be used for monetary control; an important simplification was introduced with the unification of reserve requirements in 1987. The central bank has continued to operate several preferential refinance facilities. The operation of a general discount facility was discontinued in 1984.

Weekly auctions of treasury bills were introduced in early 1987 and since then have become the main monetary control instrument. The auctions have in principle been open to all. Since late 1987, the amount to be auctioned has been determined by a forecasting committee, consisting of central bank and treasury officials, but has been largely based on the amount of bills maturing. The cutoff yield has been determined by a Tendering Committee, chaired by the Senior Deputy Governor of the central bank. Since early 1988 the yield has been set with a view toward the central bank’s net domestic assets—thus becoming the main operating target for short-term monetary control.

A lack of depth and competition in money and securities markets hampers monetary management in Sri Lanka. The central bank has been operating a secondary window for the purchase and sale of treasury bills. The prices at this secondary window are linked to those in the most recent auction of treasury bills with a penalty element that has varied over time. There is, however, no active market for government securities with maturities over one year. Although a substantial part of the government’s financing requirement has been covered by issuing long-term rupee securities, these have been placed with captive sources. In addition, while short-term interest rates are market-oriented, the primary treasury bill market is not fully operated according to market principles and the secondary market is still very limited.

The central bank has, therefore, used a combination of direct and indirect policy instruments to influence the growth of monetary aggregates in recent years. These have included, among other instruments, statutory reserve requirements, refinance facilities, selective credit controls, and moral suasion. Since 1992, however, greater emphasis has been placed on indirect instruments of monetary control, including open-market operations in treasury bills and central bank securities, within the context of reserve money programming.

The conduct of monetary policy in 1993 was complicated by large unanticipated inflows of interest-sensitive capital, which rendered the system of reserve money management more difficult. The main policy response of the authorities to these inflows was aggressive sterilization by open-market operations through the central bank’s secondary window and subsequently by issuing its own securities. However, a relatively passive stance to sterilization resulted in a rapid growth of reserve money in 1993. The role of market-based instruments of monetary control in Sri Lanka is reviewed in Table 2.10.

Table 2.10.Sri Lanka: Major Factors Affecting Reserve Money(In millions of Sri Lanka rupees; ended December)
19831984198519861987198819891990199119921993
Domestic financing of the government deficit6,5343,9918,5699,14311,35521,06515,85013,50916,14915,55122,258
Treasury bills80−2,5407,4203,8933,67713,85013,54610,7225,00014,12810,100
Central bank664−3,9377,3011,49317410,982828−3,4444,378−9,834−20,020
Commercial bank−572−4−41503,1841912,7574,322−1,36413,52026,806
Nonbanks−121,4011232,2503182,6789,9609,8451,9879,6413,314
Other securities13,1003,0736,3693,2817,0785,8255,3611,34413,2522,98112,7572
Other33,3333,458−5,2201,9696001,390−3,0571,443−2,103−1,558−599
Change in net claims on government by central bank4577−3,7306,7352,4957868,507466−2,192−208−1,895−13,663
Change in net foreign asset of central bank5−3975,969−3,846−5,116−4,936−1822,3445,30512,93812,46536,399
Change in autonomous net domestic assets of central bank61,579−1,013−1,2521,148−814271,3274,039−4,724−745−6,127
Change in the use of money market instruments by central bank−415−750−1,4392,58419.3−1,251511−2,243−1,236
In percent of reserve money at beginning of period−1.2−5.5−8.514.30.1−4.71.6−5.6−2.8
Central bank securities−415−750−1,4392,58419.3−2,155
Outstanding position of treasury bills in secondary market−1,2515112,243919
Change in reserve money2,5232,0703,1841,1371,2426,2921,2284,7878,4774,80211,609
In percent27.717.823.36.76.932.64.817.926.812.025.9)
Change in required reserves1,1775491,944−357−7863,1398862,4911,2164,0986,505
In percent of reserve money at beginning of period12.24.513.6−2.0−4.216.33.59.33.910.214.5)
Memorandum:
Money market interest rates7
Nominal12.413.113.410.57.313.414.814.113.816.216.5
Real−1.811.75.93.4−5.03.1−2.93.23.65.714.1
Sources: Data provided by the Sri Lankan authorities; and IMF Staff estimates.

Net of debt sinking fund.

Excludes Rp 24,088 million of bonds issued to recapitalize two state banks.

Residual.

lncludes operations in Treasury bills for monetary control purposes.

On a transactions basis, that is, excluding valuation changes.

Includes refinance and discount facilities, loans to private and public enterprises, and other items.

Treasury bill rate

Sources: Data provided by the Sri Lankan authorities; and IMF Staff estimates.

Net of debt sinking fund.

Excludes Rp 24,088 million of bonds issued to recapitalize two state banks.

Residual.

lncludes operations in Treasury bills for monetary control purposes.

On a transactions basis, that is, excluding valuation changes.

Includes refinance and discount facilities, loans to private and public enterprises, and other items.

Treasury bill rate

Thailand

The central bank has used multiple monetary targets as a guide for the conduct of monetary policy, including a monthly monetary base (or reserve money) as an operational target. The primary monetary policy instrument used by the central bank, the Bank of Thailand, has been government bond repurchases in the repurchase market operated by the central bank. This policy has been supplemented at times by the selective use of other monetary policy instruments, including the issuance of central bank bonds, a tightening of commercial bank access to refinancing facilities, and changes in the Bank of Thailand’s rediscount rate.

The money market is dominated by the government bond repurchase market established in April 1979. Government bonds, which are issued for maturities of 5, 10, or 15 years on fixed interest rates, are otherwise illiquid. The central bank acts as a principal of the repurchase transactions. It receives daily bids and offers from commercial banks for specified maturities (typically seven days and overnight). Until about May 1986, the central bank’s activity largely involved matching the bids and offers for repurchases with limited intervention on its own account. With the emergence of a high level of liquidity in the banking system in 1986, central bank intervention became more active and in May 1987, it introduced a longer-term repurchase contract with maturities up to six months. Also in May 1987, the central bank made the first issue of its own bonds. The treasury bill market is limited and has not been used for active monetary management.48 The interbank market is also thin and volatile, and a direct repurchase market among commercial banks has not emerged—partially because of the operating procedures of the Bank of Thailand.

During 1989-91, the substantial consolidation of the fiscal position taking place at the time was reflected in rising treasury deposits at the central bank and served to offset a large part of the impact of large balance of payments surpluses on the growth of reserve money. The decline in net claims on government offset, on average, about 50 percent of the contribution to reserve money growth from net foreign assets during this period. Discretionary monetary policies at this time included the issuance of B 13.4 billion in central bank bonds, a reduction in commercial bank access to refinancing facilities at the central bank, and an increase in the rediscount rate from 8 percent at the end of 1989 to 12 percent at the end of 1990.

The central bank has set maximum interest rates on bank deposits and adjusted it periodically until recently; it has used moral suasion to encourage commercial banks to adjust their interest rates, but has increasingly left interest rates to be determined by market forces. Also since 1980, the authorities removed the usury ceiling of 15 percent in the civil code, and began to adjust lending rate ceilings of banks and finance companies to reflect market conditions and cost developments. Formal interest rate liberalization began only in 1989. During 1990-92 controls on deposit rates were removed initially, then lending rates were lifted progressively. The central bank has resorted on occasion to direct credit controls, most recently in 1984. The authorities have sought to influence the direction of credit by rediscounting on a preferential basis, by imposing lending quotas, and by exempting lending to priority sectors from risk/asset ratios.

Concern over the impact of the oligopolistic structure of the banking system lead the Thai Bankers Association, representing the large commercial banks, to agree with the Bank of Thailand in October 1993 that in addition to the prime lending rate (the minimum lending rate) they would also announce a minimum retail rate to the public, with this rate serving as a benchmark for lending to general customers. The minimum retail rate was introduced to lower the cost of information, increase competition, and reduce the differential between prime and nonprime lending rates. Under this system, the minimum lending rate is announced by each individual commercial bank taking into account their own cost of funds. Banks are required to announce the criteria for qualifying for interest and discounts based on the minimum lending rate, the minimum retail rate, the maximum margin to be added to the minimum retail rate, and the maximum interest rate to be charged in case of a customer’s default. Banks are also required to post these rates openly to the public at every branch office. Although commercial banks remain free to determine their deposit and lending rates,49 the understanding reached with the central bank is that the minimum lending rate would not exceed 2 percentage points above the average cost of deposits and the minimum retail rate would not exceed 2 percentage points above the minimum lending rate. The maximum lending rate would be 2 percentage points above the minimum retail rate. Within these ranges, the actual rate for any individual borrower would depend on the customer’s credit rating. The role of market-based instruments of monetary control in Thailand is reviewed in Table 2.11.

Table 2.11.Thailand: Major Factors Affecting Reserve Money(In billions of Thai baht; ended December)
1984198519861987198819891990199119921993
Domestic financing of the government deficit35.931.650.210.6−28.8−11.2−11.9−46.9−28.6−44.3
Of which: Bank of Thailand−3.311.3−5.9−8.6−47.9−7.97.35.1−1.8−14.1
Treasury Bill−3.24.8−5.25.0
Bonds−2.24.70.9−3.1−26.8−8.46.34.4−0.6−11.4
Other39.120.356.219.319.1−3.3−19.2−51.9−26.8−30.2
Treasury Bill5.0−5.74.9
Bonds25.317.031.015.65.0−3.2−12.5−48.2−16.3−21.8
Change in net claims on government by central bank−5.28.5−9.4−7.0−51.5−54.6−36.9−61.3−21.9−23.8
Change in net foreign assets of central bank10.85.614.318.059.193.890.3101.573.997.5
Change in autonomous net domestic assets1 of central bank5.15.013.56.715.2−12.31.0−6.50.6−14.0
Change in the use of money market instruments by the central bank−0.91.2−2.90.02.0−2.81.40.84.51.2
In percent of reserve money at beginning of period−11.81.5−3.40.01.7−2.10.90.42.10.5
Credits for liquidity purposes−0.91.2−1.0−0.20.30.9−12.09.41.41.4
Bank of Thailand bonds2
Repurchase agreements in government bonds−1.90.21.7−3.713.4−8.63.13.1
Change in reserve money4.26.88.821.417.322.729.124.735.540.1
In percent5.37.79.218.312.914.515.711.715.113.9
Change in required reserves6.14.05.17.110.516.820.820.221.127.0
In percent of reserve money at beginning of period8.15.05.97.59.012.513.310.910.010.9
Money market interest rates (in percent)
Nominal13.613.58.15.98.79.812.710.67.1
Real11.211.75.72.23.64.27.36.63.7
Sources: IMF, International Financial Statistics; data provided by the authorities; and IMF staff estimates.

Includes refinance and rediscount facilities, and loans to private and public enterprise.

Outstanding amount was 2 billion baht in the period June-October 1984.

Sources: IMF, International Financial Statistics; data provided by the authorities; and IMF staff estimates.

Includes refinance and rediscount facilities, and loans to private and public enterprise.

Outstanding amount was 2 billion baht in the period June-October 1984.

Appendix III: Estimates of Money and Credit Demand and Tests of Stability
Table 2.12.Determinants of Monetary and Credit Growth(Dependent variable ΔlnM)
Dependent VariableConstantΔln YΔln PrdrfIn (M−1/Y)R2SEE
Indonesia
Currency
1970-840.230.61−0.260.004−0.0060.030.210.065
(0.22)(2.03)(0.66)(0.81)(0.68)(0.08)
1970-92−0.710.41−0.11−0.004−0.011−0.310.140.078
(0.78)(1.26)(0.24)(1.01)(1.34)(1.01)
Broad money
1970-84−0.170.49−0.120.002−0.0030.170.630.052
(0.98)(1.76)(0.37)(0.41)(0.58)(1.64)
1970-92−0.060.63−0.280.0060.001−0.080.460.062
(0.58)(2.43)(0.79)(1.98)(0.10)(2.37)
Private sector credit
1970-84−0.26−1.612.30−0.01−0.03−0.500.440.187
(0.79)(1.94)(2.08)(0.86)(1.53)(2.48)
1970-92−0.12−1.201.750.01−0.01−0.180.200.19
(0.41)(1.53)(1.61)(1.08)(0.35)(2.22)
Kenya
Currency
1970-90−1.270.82−0.79−0.0030.001−0.470.600.04
(2.36)(2.02)(2.82)(0.90)(0.02)(2.48)
1970-92−0.760.56−0.07−0.001−0.009−0.300.290.063
(1.00)(0.99)(0.22)(0.09)(2.09)(1.15)
Broad money
1970-90−0.700.57−0.24−0.0050.001−0.610.440.066
(2.05)(0.87(0.54)(1.03)(0.13)(2.26)
1970-92−0.490.360.37−0.003−0.008−0.480.330.076
(1.29)(0.49)(0.86)(0.52)(1.39)(1.57)
Private sector credit
1970-90−0.76−0.120.30−0.0050.008−0.480.510.051
2.48(0.30)(0.89)(1.20)(1.44)(3.33)
1970-92−0.69−0.390.76−0.0040.002−0.460.450.056
(2.10)(0.99)(2.72)(1.00)(0.42)(2.99)
Malaysia
Currency
1970-90−0.220.200.51−0.007−0.007−0.160.400.049
(0.57)1.161.21(1.24)(1.55)(0.93)
1970-92−0.310.140.24−0.01−0.002(−0.19)0.350.053
(0.72)(0.77)(0.56)(2.39)(0.56)(1.09)
Broad money
1970-90−0.030.26−0.160.0020.005−0.130.440.047
(0.37)(1.75)(0.37)(0.03)(1.01)2.57
1970-920.020.330.280.005−0.002−0.090.280.054
(0.27)(1.92)(0.63)(0.81)(0.53)(1.65)
Private sector credit
1970-90−0.120.49−0.410.0090.01−0.100.450.065
(1.33)(2.34)(0.69)(1.08)(1.85)(2.61)
1970-92−0.100.52−0.240.010.009−0.090.440.063
(1.21)(2.55)(0.46)(1.39)(1.84)(2.57)
Mexico
Currency
1970-88−1.720.53−0.480.0010.001−0.580.780.098
(1.76)(0.90)(0.10)(0.28)(0.15)(1.79)
1970-92−0.740.83−0.500.0020.002−0.240.760.093
(1.18)(1.64)(1.15)(0.87)(0.33)(1.23)
Broad money
1970-880.151.11−0.950.004−0.0030.010.26
(0.16)(0.78)(0.75)(0.69)(0.09)(0.03)
1970-92−0.160.85−1.130.0070.004−0.170.060.243
(0.34)(0.63)(0.97)(1.39)(0.22)(0.75)
Private sector credit
1970-88−0.301.85−0.35−0.004−0.01−0.140.170.29
(0.31)(1.15)(0.24)(0.58)(0.34)(0.51)
1970-920.371.98−0.81−0.002−0.030.040.110.283
(0.90)(1.28)(0.62)(0.26)(1.31)(0.27)
Philippines
Currency
1970-841.45−0.12−0.120.004−0.01−0.320.140.105
(1.33)(0.14)(0.16)(0.33)(1.13)(1.18)
1970-921.220.40−0.540.004−0.007−0.280.010.086
(1.97)(0.78)(1.21)(0.75)(0.94)(1.78)
Broad money
1970-84−0.130.47−0.800.01−0.0040.050.080.086
(0.11)(0.67)(1.30)(1.47)(0.50)(0.20)
1970-921.040.66−0.730.010.000−0.190.000.004
(1.33)(1.35)(1.73)(1.79)(0.03)(1.29)
Private sector credit
1970-84−1.551.01−0.19−0.040.010.350.470.73
(0.89)(1.68)(0.29)(1.96)(1.17)(0.99)
1970-920.870.93−0.54−0.0080.01−0.150.170.13
(1.22)(1.20)(0.81)(1.09)(1.21)(1.08)
Sri Lanka
Currency
1970-90−1.28−0.090.19−0.002−0.01−0.550.220.088
(2.50)(0.19)(0.30)(0.42)(1.14)(2.75)
1970-92−1.32−0.150.14−0.004−0.007−0.560.210.086
(2.69)(0.33)(0.23)(0.81)(0.78)(2.89)
Broad money
1970-90−0.400.25−0.570.010.01−0.280.050.092
(1.12)(0.37)(0.80)(1.52)(0.66)(1.28)
1970-92−0.390.26−0.570.0080.007−0.270.090.087
(1.21)(0.42)(0.85)(1.79)(0.77)(1.38)
Private sector credit
1970-90−0.430.86−0.550.02−0.19−0.190.290.110
(1.27)(1.19)(0.66)(2.25)(0.89)(1.24)
1970-92−0.420.87−0.520.02−0.01−0.190.310.104
(1.33)(1.30)(0.68)(2.51)(1.32)(1.30)
Thailand
Currency
1970-85−0.730.16−0.05−0.020.001−0.350.170.048
(1.22)(0.40)(0.14)(1.65)(0.20)(1.40)
1970-92−0.790.20−0.11−0.020.002−0.360.360.042
(2.24)(0.70)(0.41)(2.41)(0.49)(2.56)
Broad money
1970-850.150.100.120.001−0.002−0.010.330.40
(1.02)(0.26)(0.35)(0.16)(0.37)(0.12)
1970-920.110.41−0.110.005−0.0030.0010.030.037
(1.86)(1.68)(0.44)(0.95)(0.66)(0.03)
Private sector credit
1970-850.181.23−0.36−0.0040.000.040.360.60
(0.39)(2.57)(0.78)(0.20)(0.01)(0.31)
1970-920.181.23−0.36−0.0040.000.040.380.060
(0.39)(2.57)(0.78)(0.20)(0.01)(0.31)
Sources: Data provided by the country authorities; IMF, International Financial Statistics; and IMF staff estimates.Note: Data in parentheses indicate t-statistics.
Sources: Data provided by the country authorities; IMF, International Financial Statistics; and IMF staff estimates.Note: Data in parentheses indicate t-statistics.
Table 2.13.Test of Homogeneity (F-Statistic)1
Residual sum of squares
1970-92

(1)

RSS1
19702

(2)

RSS2
Computed F 2,3
Indonesia
Currency.1035.03851.69
Broad money.0660.02451.70
Credit to private sector.6198.31460.97
Kenya
Currency.0670.02899.25
Broad money.0978.06563.43
Credit to private sector.0367.05263.03
Malaysia
Currency.0471.03602.16
Broad money.0500.03283.67
Credit to private sector.0688.06375.60
Mexico
Currency.1479.12380.59
Broad money1.0054.87820.43
Credit to private sector1.35831.39724.00
Philippines
Currency.1253.09930.26
Broad money.0665.11180.68
Credit to private sector.2696.04794.63
Sri Lanka
Currency.1242.11700.18
Broad money.1272.12710.00
Credit to private sector.1821.18164.00
Thailand
Currency.0301.02340.37
Broad money.0232.01620.56
Credit to private sector.0487.03610.45

Whenever the computed F exceeds the critical F level, one should reject the hypothesis that the results of the individual equations are consistent. In this test, the critical F at 99 percent level of significance is 4.29; and at 95 percent of significance is 2.74.

With estimation cut-off period: For lndonesia-1984, Kenya-1990, Malaysia-1990, Mexico-1988, the Philippines-1984, Sri Lanka-1990, and Thailand-1985.

where K = 6. Bold type indicates instability in demand following the reform of monetary instruments.

Whenever the computed F exceeds the critical F level, one should reject the hypothesis that the results of the individual equations are consistent. In this test, the critical F at 99 percent level of significance is 4.29; and at 95 percent of significance is 2.74.

With estimation cut-off period: For lndonesia-1984, Kenya-1990, Malaysia-1990, Mexico-1988, the Philippines-1984, Sri Lanka-1990, and Thailand-1985.

where K = 6. Bold type indicates instability in demand following the reform of monetary instruments.

Note: This chapter is based on IMF Working Paper 89/48 (1989), “Monetary Control Procedures and Financial Reform: Approaches, Issues, and Recent Experiences in Developing Countries,” and has been revised and includes updated statistical and country specific information. We are grateful to Dawit Makonnen for research assistance.

1

“Open-market-type operations” also include other market-based instruments, such as credit auctions, deposit auctions, and similar instruments, that do not rely on the existence of developed securities markets.

2

This may occur when savings mobilization is inhibited because a given level of bank credit is associated with higher consumption, and also when disintermediation occurs, because recorded bank credit underestimates the total credit available in the economy through both regulated and unregulated financial institutions.

3

Within regulated systems without capital markets, the financing of such projects often requires official subsidies through preferential central bank refinance facilities, from the budget, or through development finance institutions. A reliance on central bank refinance interferes with the central bank’s capacity to control reserves of the banking system, and undermines its independence, while the experience with development finance institutions in identifying and financing viable projects has not been very positive.

4

An increasing number of central banks target the final objective of low inflation directly and do not rely on an announced intermediate target, although intermediate targets and indicators continue to be used to guide policy implementation. Under direct inflation targeting, the inflation forecast may serve as a form of intermediate target for determining the necessary adjustment in the monetary instruments.

5

The Group of Ten consists of Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, the United Kingdom, and the United States. Effective January 1, 1999, when the exchange rates of the national currencies of the countries participating in EMU became irrevocably locked, a common monetary policy determined by the European Central Bank applies in Belgium, France, Germany, Italy, the Netherlands, and the other members participating in EMU.

6

One or two countries also have carryover provisions for reserve surplus or deficiencies from one reserve holding period to another.

7

See Quintyn (1994) for a discussion of the choice between central bank and treasury securities for monetary control.

8

In practice, countries need instruments to absorb as well as inject reserves, and hence, use both securities and credit auctions, and over time transform credit auctions into repurchase auctions using treasury or central bank bills.

9

The same principles apply to the use of other instruments such as credit auctions of a mix of instruments.

10

Issues of primary bills could also in principle be held frequently, but because sales of bills to the general public involve administrative costs and delays associated with advertising the sale, receiving and filling bids, and similar operations, primary bill issues have tended to occur no more than once a week.

11

In some countries where the central bank has been inactive in the money markets, commercial banks have built up large precautionary reserve balances, apparently to meet short-term fluctuations in their liquidity, although this buildup has also often been accompanied by official concerns about “excess liquidity” and the underuse of commercial bank resources. For a theoretical treatment of the optimal holding of precautionary balances in the face of uncertainty see Sprenkle and Miller (1980). The proposed use of reserve requirements with compliance on a period average basis by the European Central Bank has also been justified by the expectation that this would reduce the need for dayto-day money market intervention.

12

Penalties associated with borrowing from the central bank may reflect quotas that restrict access, rather than specifically posted penal rates.

13

Graduated access could be provided in a number of ways, including the use of quotas and credit tranches for accommodation from the central bank.

14

In principle, direct intervention in the unsecured interbank market, such as the auctioning of deposit placements or other similar devices, is possible for day-to-day control. The choice would depend upon the institutional circumstances.

15

When shortages are indicated, the central bank would typically announce its willingness to buy bills up to a certain amount, and ask for competitive offers from banks and other money market participants; when surpluses are indicated the central bank would announce its willingness to sell a certain volume of bills, and ask for competitive bids.

16

Information to be monitored would include: (1) the size of government payments or exchange market intervention by the central bank; (2) interbank rates throughout the day; (3) assistance provided through the loan window (if such a facility existed); (4) the ex post monitoring of developments in the central bank balance sheet components, relative to the forecast used to determine the size of the primary bill issue; and (5) commercial bank progress in meeting cash reserve requirements.

17

On the question of sequencing fiscal adjustment with financial sector reform, see Johnston (1997). Issues in the coordination of monetary and public management during financial reform are discussed in Sundararajan, Dattels, and Blommestein (1997).

18

See Johnston (1993) for a discussion of the design of financial programs with the adoption of indirect monetary controls.

19

For example, in Thailand, ceilings on savings deposits and loan rates were eliminated in January 1992 and June 1992, respectively, but Thai banks were required to post a minimum lending raw that takes into account the average cost of funds and a minimum retail rate for loans to general customers. There was an understanding that the minimum lending rate would not exceed the average cost of deposits by more than 2 percent, the minimum retail rate would not exceed the minimum lending rate by more than 2 percent, and the maximum loan rates would not exceed the minimum retail rate by more than 2 percent; see Johnston (1991b).

20

In Argentina, the central bank auctions central bank bills issued against its holdings of government securities (this practice has been named “participations”).

21

See Baliiio, Johnson, and Sundararajan (1996) for a discussion of linkages between payment systems and monetary policy.

22

The available information for Argentina and Brazil was not adequate for the preparation of this type of statistical analysis.

23

See Appendix I for a theoretical analysis leading to this presentation.

24

The prereform periods are Indonesia, 1970-84; Mexico, 1970-88; Philippines, 1970-84; Sri Lanka, 1970-90; and Thailand, 1970-85.

25

In Indonesia, bank credit continued to be heavily dependent on central bank refinance, while in Thailand the credit markets remained relatively uncompetitive (see Appendix II).

26

Similar constraints on interest rates and exchange rates would apply in the absence of a formal forward exchange market. For further discussion of the implications of these relationships for monetary and exchange rate policy, see Chapter 4.

27

Such frameworks include interest rate targeting in the short-term combined with annual or medium-term frameworks based on inflation targeting; reliance on a wider range of indicators rather than a single monetary aggregate; greater attention to movements in the exchange rate in assessing monetary conditions, including in the context of monetary conditions indicators; and revisions in the targeted definition of money.

28

When the central bank adopts a reserves operating framework, it may nevertheless seek to exploit the direct multiplier link between bank reserves and money supply. For a given level of reserve money, reserve requirements can impose an upper limit on the money supply where there is a non-interest-sensitive demand for excess reserves. Reserve requirements may also be used to help ensure that the demand for central bank money is sufficiently stable when the central bank seeks to achieve its monetary objectives by controlling short-term interest rates.

29

The trend toward a reduction of the ratio of required reserves can be observed in all the industrial countries. Where the level of the ratio is comparatively high, as in Italy, remuneration partly offsets the tax element. In the United Kingdom, reserve requirements are no longer used as a monetary instrument. No reserve requirements are in place in Belgium and Sweden. In Canada, arrangements in place amount to a zero percent ratio.

30

For example, Germany restricts the sale or issue locally by nonresident banks of deutsche mark-denominated certificates of deposit with a maturity of less than two years. The measure is to preserve the effectiveness of reserve requirements by achieving uniform treatment of resident banks, which are subject to reserve requirements, and nonresident banks, which are not.

31

The impact of the imposition of the reserve requirement can also be examined from the point of view of the foreign investor, where the impact of the reserve requirement will reduce the return to the investor after account is taken of the cost of holding the reserve requirement. If id, is the nominal domestic interest rate, then the return to the foreign investor after the imposition of the reserve requirements falls to id (1 - r). The subsequent discussion would follow whether the analysis is from the point of view of domestic borrower or the foreign investor.

32

Fd=(efet-1)X100. Therefore, for Fd<Fd, with a given forward rate, the spot exchange rate (es) would have to rise, that is, depreciate. If the spot rate is fixed, then the whole adjustment would have to fall on the domestic interest rate.

33

The implementation of the reserve requirement on shorter flows would have the initial effect of tilting the yield curve to foreign investors by reducing returns on short-term instruments relative to longer-term investments. To the extent that covered interest rate parity is reestablished, however, the effective returns to foreign investors would return to their previous level, and the tilting of the yield curve of returns to foreign investors would only be temporary.

34

On the effectiveness of the measure in Germany in the 1970s, see Johnston (1983). A recent study on the effectiveness of controls in Chile by Soto (1997) finds that the reserve requirement had an effect on the domestic interest rate and nominal exchange rate that lasts for between a year and a year and a half. The reserve requirement significantly alters capital flow composition, leading to a relative decline in short-term capital flows. This decline is prolonged over time, although no quantitative assessment is provided. Soto concludes that “…the impact of the measure is in the expected direction, i.e., it reduces capital inflows, keeps domestic interest rates higher, depreciates the real exchange rate, and changes the composition of capital inflows. However, the economic importance of these effects are minimal.”

35

This section illustrates the relationship between the treasury bill issue and control of the reserves of the banking system; a similar relationship can be derived for central bank bill issues or other debt issues by the government.

36

This assumes a uniform reserve ratio is applicable to all bank deposits. With lagged reserve accounting, required reserves would be based on deposits in a previous time period and may be known before deciding on the amount of treasury bills to be issued.

37

While automatic access by banks to central bank loan or rediscount facilities could reduce precautionary reserve holdings to a low level, the charging of penalty interest rates or uncertainty over the level of interest rates charged by the central bank would still lead to precautionary reserve holdings by banks.

38

The following analysis is in terms of the deficiency in desired holdings rather than required holdings. Since desired holdings include a precautionary reserve, the implications for interest rates, etc., are likely to be different when dCBD>dCBS>αdD* and dCBS<αdD*.

39

The need to resort to the central bank for marginal accommodation may occur before aggregate shortages emerge in reserves if the interbank system is inefficient.

40

Sometimes a distinction is made between “defensive” central bank operations, which are designed to offset the impact of autonomous influences on the supply of reserves, and “dynamic” operations, which are designed to bring about changes in the supply of reserves.

41

Bills of 15-day maturity were also issued for a brief period in 1984—85.

42

These auctions—telephone go-around—are conducted through FICORINVEST.

43

Between January 1989 and January 1994, alone, the required reserve ratio was raised seven times.

44

The auctions, which were introduced in 1973, have been conducted on a weekly basis, with 91-day bills offered every week, 182-day bills every second week, and 364-day bills every four weeks. The amounts and maturities to be offered are announced in advance of the auction; results regarding, inter alia, amounts tendered, accepted and rejected, and yields are announced after the auction. Given the captive holding requirements, the treasury bill yields do not properly reflect money market conditions.

45

The central bank has operated two categories of discount facilities. First, commercial banks and other eligible institutions (finance companies, merchant banks, discount houses) may discount treasury bills and eligible short-term commercial, industrial, agricultural, and other business bills. Second, eligible institutions may seek a direct advance from the central bank, against collateral of paper eligible for rediscounting. A common discount rate is applied to both windows.

46

See Leite (1985) for an overview of open-market-type operations in Mexico.

47

Base money is defined as reserve money plus bank holdings of reserve eligible securities and reserve deficiencies.

48

Bills are auctioned on a weekly basis and are purchased mainly by financial institutions to satisfy statutory requirements. Between auctions, the central bank usually stands ready to sell bills from its portfolio and has occasionally purchased bills before maturity.

49

The ceiling on all time deposit rates was removed in March 1990, while ceilings were lifted on saving deposits in January 1992 and on loan rates in June 1992.

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