BSP plans to implement interest rate corridor

Bangko Sentral ng Pilipinas on Wednesday disclosed a plan to implement an interest rate corridor system by the second quarter of 2016 to improve transmission of its policy moves.

The Philippine central bank joins India in seeking to ensure monetary policy changes are better reflected by actual borrowing costs in the economy.

Tetango said while the shift was not a change in the monetary policy stance, it would help improve the transmission of benchmark-rate adjustments to relevant money market rates.

“The transition to the new interest rate framework is very timely in view of the current favorable inflation and output conditions,” said Tetangco, who has kept the key interest rate unchanged all year.

The new system will also help reduce the country’s reliance on the reserve requirement for sterilization operations, allowing the central bank to cut the requirement in the future “in line with regional norms,” he said.

Improving the transmission of any monetary stimulus or policy adjustment is gaining importance as global growth falters and amid elevated market risks. In India, where the central bank made the biggest rate cut since 2009 Tuesday, Governor Raghuram Rajan is turning his attention to the country’s lenders who have been slow to pass on rate cuts earlier this year.

Tetangco said the system would introduce key changes in the framework for monetary operations designed to enhance the effectiveness of monetary policy.

“These changes will help improve the transmission of policy rate adjustments to relevant money market rates, and ultimately to key macroeconomic variables,” Tetangco said.

Infrastructure requirements include two standing liquidity facilities--deposit and lending--whose rates will form a corridor around the BSP’s policy rate, and will be supported by auction-based monetary operations.

Tetangco said there were two objectives in the implementation of the interest rate corridor. First would be to strengthen the signaling effect of policy rates and, to provide a system to allow easier price discovery part in the money market.

“Normally, a central bank would have interest rates at which it lends to banks [lending rate or RP rate] and the central bank has a deposit rate [SDA rate]. The lending rate would  normally be above and deposit rate below,” Tetangco said.

Tetangco said money market rates would follow the Bangko Sentral rate. He said basically using a single instrument for open market operations, the term deposit auction facility would allow the Bangko Sentral to siphon excess liquidity in the financial system.

“In terms of timing, there will be an auction which right now is being planned to be conducted once a week. The amount to be auctioned will be based on a liquidity forecasting model. The  critical ingredient is liquidity forecasting model,” Tetangco said.

Tetangco said the term deposit facility rate would be somewhere around the middle of RRP rate.

“We intend to conduct consultations with the industry starting next month to get their feedback, as to how to operate this corridor effectively and we intend to start using the interest corridor during the second quarter next year,” Tetangco said.

Bangko Sentral said over time, the interest rate corridor system would also help reduce the country’s reliance on reserve requirement for sterilization purposes, allowing the BSP to lower in the future the reserve requirements in line with regional norms.

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