“Liquidity Management Via Interest Rate Corridor in Pakistan- and Experience of Other Countries’ Emerging Markets”

STATE BANK OF PAKISTAN SUMMER INTERNSHIP PROJECT REPORT 2011 Liquidity focal point via Interest deem Corridor in Pakistan- and Experience of Other Countries Emerging Markets Submitted to Sir Mubarak By Tooba Sarfaraz Rafia Parvez Sumbul Masood Introduction to recite Bank of Pakistan State Bank of Pakistan, the central bank of the unpolished was established in July 1948 I. e. , within one year after Pakistan gained independence. being the central bank, it regulates the financial policy and the credit system of the country to foster its harvesting in the best national interest with a view to arrest fiscal constancy and to fully utilize the productive resources of the country. The banks operations also include preserving the value as well as maintaining stability in the Banking system. Vision To transform the SBP into a modern and dynamic central bank, highly professional and efficient, fully equipped to play a meaningful situation in sustainable basis in the economical and s ocial development of Pakistan. Mission To promote monetary and financial stability and foster a extend and dynamic financial system, so as to achieve, sustained and equitable economic growth and prosperity. Introduction to Domestic grocery stores and monetary management department (DMMD) Domestic Markets and monetary management department was created in Sept 2006 as a result of comprehensive restructuring within State Bank of Pakistan with the neutral of transforming the central bank into a dynamic institution more responsive to the growing sophistication in the financial markets. DMMD is an off adopt of the previous Exchange and Debt ManagementDepartment (EDMD), which was established in Feb 2000. Vision To illust score a proactive, professional and planned approach for effective management of exchange and debt markets so as to contribute towards accomplishment of exchange and monetary policy objectives. Mission DMMD strives to set performance benchmark within SBP and Pakista ns financial markets. Departmental goals The core objective of DMMD is to implement the monetary policy objective of the State bank of Pakistan by using the available tools in both the money and alien exchange markets.Departmental objectives * Monetary Policy Implementation a. tending of stable interest strides in inter-bank money market through proactive management of money market liquidity. b. Raising short term government activity debt and developing yield curve through auction of market treasury bills c. Proactive management of money market liquidity through open market operations d. Liquidity management through interest rate corridor system. * Exchange Rate Policy Management a. Stable exchange rates and Forward premiums at appropriate /sustainable levels b.Sale and purchase of third currencies at optimum prices c. Smooth and sufficiently liquid foreign exchange markets d. Optimal accumulation of foreign exchange re servicings and forward portfolio * Reserve Management a. Op timal utilization of reserve portfolio and maximum returns on investment of surplus reserves. Hiring of investment consultants and fund managers for optimizing returns. * Debt Management a. Domestic debt i. Developing the markets for government securities ii. Coordination betwixt monetary and fiscal policies iii. Raising short term and long term domestic debt for the government v. Data fore management of permanent and floating debts. b. External debt i. Monitoring and ensuring prompt payment of external debt installments through state bank of Pakistan and commercial banks. Introduction of an Interest Rate Corridor In order to reduce the volatility in short term interest rates and to bring more transparency in the implementation of monetary policy, State Bank of Pakistan has decided to introduce an interest rate corridor for the money market overnight repo rates. The corridor get out operate through standing overnight repo / reverse-repo facilities (i. . degree & ceiling), settin g a formal corridor for the money market overnight repo rates consistent with the monetary policy of State Bank of Pakistan. The salient features of the interest rate corridor are as follows 1. The interest rate corridor will consist of two end-of-day Standing facilities offered by State Bank of Pakistan Existing SBP 3-day Repo Facility will be renamed as SBP Overnight Reverse-Repo Facility, which will become the Ceiling and a new SBP Overnight Repo Facility to absorb excess finances from the market will serve as the Floor of the corridor. . The procedure for availing the end-of-day financing facility from State Bank of Pakistan at the Ceiling rate in case the market is short of funds will continue to be in accordance with the existing practices and instructions issued by State Bank of Pakistan from time to time in reference to the SBP 3 day Repo Facility (now renamed as SBP Overnight Reverse-Repo Facility) against Government of Pakistan Market Treasury Bills and Federal/Pakistan In vestment Bonds. 3.The overnight end-of-day standing repo facility at the Floor rate will be available to plan banks and primary dealers which are left with excess funds in the interbank market. These funds can be placed with State Bank of Pakistan in the form of an overnight repo against Treasury Bills at the Floor rate. Some of the operational details are as under a. Only scheduled banks and primary dealers will be eligible to place the funds at the Floor rate with State Bank of Pakistan . This facility will only be available at the end of the day, when it can be ascertained that the market has excess funds. c. The time for intimating this amount to the State Bank of Pakistan will be between 230pm to 3. 30pm from Monday to Friday and between 1200pm to 1. 00pm on Saturday. (Specimen format is enclosed). d. The minimum amount for the Overnight Repo/Reverse Repo Facility will be PKR. 100 million, and in multiples of PKR. 50 million thereof. e.The Treasury Bills acquired under the Sta nding Overnight Repo facility from State Bank of Pakistan will be SLR eligible. 4. The Floor and the Ceiling rates (and the width of the corridor) will be advised by the State Bank of Pakistan from time to time as deemed necessary. 5. State Bank of Pakistan will continue to conduct term uncivil Market Operations (OMOs) in the form of repos/ reverse-repos as per current practice in addition to these standing facilities. 6. The interest rate corridor will be relevant from 17Aug, 2009. i. MONETARY POLICY Monetary policy is the mechanism or the process through which the government, the central bank or the monetary authority of any country controls or determines the (a) supply of money, (b) the availability of money, (c) the cost of money or the interest rate, keeping in mind the broad strategic objectives of the state regarding price level, growth and stability in an economy and the overall policies that supports or under which people would want to start businesses and provide employm ent.When the incident of 9/11 happened, the overall economic environment of the world was affected very seriously and an impact of tightening monetary policy also falls. After the incident the foreign investment shoot up and flow of money continuously increased, although the value of money was stabilized but it causes inflation in many countries as well as in Pakistan. The inflow of foreign remittances resulted in inflationary pressure.In 2001, SBP revised its policy to control the flow of money. Since 2004, SBP in continuously issuing monetary policy education biannually from Jan-June and second from July-Dec. TOOLS FOR IMPLEMENTING MONETARY POPLICY To implement its objectives , some tools are required 1. Direct Instruments 2. Indirect Instruments DIRECT INSTRUMENTS * Cash Reserve Requirements (CRR) * Statutory Liquidity Requirements (SLR) silver RESEVE REQUIREMENTS (CRR)