Bank of Slovenia’s Operational Monetary Policy From the pre-ERM II phase to ERM II and the gradual approach harmonising the operational monetary policy

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  • Bank of Slovenias Operational Monetary Policy From the pre-ERM II phase to ERM II and the gradual approach harmonising the operational monetary policy framework to the Eurosystem Peter Kukanja Peter Kukanja
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  • 2 Slovenia Facts and Figures Independent since 1991, EU member since 2004 Currencies: Slovenian tolar - SIT (1991 2006), (2007 ) Population: 2.0 million GDP 29.7 billion , per capita 14,811 (2006) GDP real annual change: 5.2% (2006) Unemployment rate (ILO): 5.0% (Feb 2007) Annual inflation rate: 2.3% (Feb 2007) BoP current account: 2.6% GDP (2006)
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  • 3 Slovenia Financial Environment Credit institutions (end 2006): 21 banks 3 saving banks 2 subsidiaries Banks balance sheet total: 120% of GDP (end 2006) Financial markets: treasury bills treasury bonds Eurobonds domestically issued bonds listed on the Ljubljana Stock Exchange bank and corporate bonds equities
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  • 4 Before Accession to the EU Independent monetary policy Free selection of exchange rate regime Countries have to: ensure the independence of the central bank ensure the prohibition of financing the state ensure the liberalisation of international capital flows Slovenia: Sep 1999: new foreign exchange legislation Jun 2000: a schedule of the liberalisation of international capital flows was accepted Jul 2002: a new Bank of Slovenia Act
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  • 5 Slovenia as EU Candidate Country Preparation for the adoption of the euro (obligatory after joining the EU) Main task: to bring the rates of price growth in line with the level of Maastricht criterion before the accession to the EU and formation of a long-term and sustainable exchange rate of tolar against the euro macroeconomic balances and stability Main challenge: how to control inflation at a fixed exchange rate regime and liberalised international capital flows Monetary policy is one of the key factors in decreasing the price growth
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  • 6 Fulfilment of Maastricht criteria as of September 2001 November 2001: adopted the Medium-term Monetary Policy Framework with goal to enter the EMU as soon as possible (Banka Slovenije) November 2003: adopted the Programme for ERM II Entry and Adoption of the Euro (Banka Slovenije and Slovenian government) Convergence criterion Slovenia Inflation (in %) Long-term interest rates (in %)6.9213.96 Deficit (in % of GDP)-3.0-2.3 Public debt (in % of GDP)60.025.1
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  • 7 Inflation
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  • 8 Interest Rate Transmission Channel Normal conditions: with changing the interest rates of the monetary policy instruments it is possible to control the growth of monetary aggregate M3 Slovenia: possible to control M1, but not M3 Reasons: use of indexation of the lending and deposit interest rates slow adjustments in cost of refinancing commercial banks at the central bank surplus structural position in the money market banks can manage liquidity independently (with changes in the assets side of the balance, not in the liabilities side)
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  • 9 Exchange Rate Transmission Channel General: Changing the intervention foreign exchange rates, foreign exchange buying/selling Slovenia: Banka Slovenije controlled the dynamics of the foreign exchange market rate growth controlled imported prices influenced on the growth of the CPI influence also on borrowings of companies and banks abroad indirect influence on total credit supply for financing domestic demand defined the relative price ratios of domestic and foreign goods and services impact on external economic balance
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  • 10 Tolar vs Exchange Rate
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  • 11 Operational Monetary Policy (pre EU) Two pillars strategy (since Nov 2001): Monetary aggregatesReal economic activity indicators liquidity of the banking systembalance of payments short-term interest rate trendforeign interest rates and interest rate difference structure of monetary aggregatesforeign exchange rate credit activity of commercial bankswages in the economic and public sector price rises under the control of government
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  • 12 Restrictions in Conducting Monetary Policy Liberalisation of credit operations requires systemic regulation and supervision of foreign exchange and liquidity risk management Underdeveloped foreign exchange and tolar money market ineffective transfer of information from BS to real sector Structural position in the money market prevents fast development of money market operations Minimum reserves system high cost of financial intermediation of commercial banks
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  • 13 Structural Position and Liquidity Gap
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  • 14 Implementation Tools Two groups of tools for implementation of the monetary and exchange rate policy 1.Group of instruments foreign exchange rate dynamics maintaining external balance interest rates on a temporary sale or purchase of the foreign exchange to or from Banka Slovenije influence on the volume of base money standing facilities, open market operations, minimum reserves 2.Group of measures capital adequacy directive avoided exposure of banks to foreign exchange risks tolar and foreign exchange liquidity ladder avoided liquidity risk
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  • 15 Monetary Policy Instruments InstrumentTypeMaturityFrequencyLiquidity Repurchase agreement Open market operation one weekdailyproviding Lombard loan Standing facility overnightunlimited access providing Tolar denominated bills Open market operation 60 / 270 daysunlimited access / weekly absorbing Overnight deposit Standing facility overnightunlimited access absorbing Accepted collateral: Banka Slovenijes bills & long-term deposit, Republic of Slovenia treasury bills
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  • 16 Minimum Reserves Gradual alignment to the ECB regulations: lowering the rates of reserves to the ECB levels sights deposits (from 12% in 2001) fixed term deposits (from 6%, 2% and 1% depending on maturity, in 2001) adjustment of the basis for the computation according to the maturity equalising the treatment of the tolar and foreign exchange obligations the increase of the interest rate from 1% to a market level
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  • 17 Interest Rates Convergence
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  • 18 Operational Basis of Exchange Rate Actions Large capital inflows and the resulting excess liquidity active exchange rate policy operations Three main elements: agreement between Banka Slovenije and banks (Bank Club) temporary purchases of foreign currency by Banka Slovenije 7-day foreign currency swap (temporary monetisation of foreign currency inflows) sterilisation operations through the issuance of the tolar denominated central bank bills (60 and 270 day maturity)
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  • 19 After Accession to the EU General: countries have to accede to the ERM II mechanism ERM II: rate of national currency is set against the euro (central parity rate) allowed fluctuation 15% (standard fluctuation band), exchange rate intervention Conditions for accession to the EMU: fulfilled nominal convergence criteria based on Maastricht criteria: price stability long-term interest rates general government deficit / public debt participation in the ERM II mechanism for at least two years
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  • 20 Slovenia in the ERM II period: 28 Jun 2004 31 Dec 2006 monetary policy in line with the maintenance of the stability of the nominal tolar exchange rate central parity rate: 1 = 239.640 SIT lower point: 203.694 SIT upper point: 275.586 SIT calculated average deviation rate: 0.05% no major excess of supply or demand of foreign exchange central rate was at a level sustainable in a long-term small deviations no need for intervention
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  • 21 Transition to the Eurosystem (1) Structural adjustments to ease the transition: replacement of 270-day tolar bills with long-term deposit as a sterilisation instrument maturities in 2007 floating interest rate: 0.2% above 60-day tolar bill final abolition of the minimum foreign currency liquidity requirement and replacement of swaps with outright purchases of foreign exchange (final abolition of and $ denominated bills) final adjustment of the reserve requirement instruments to the arrangements in the euro area excess liquidity had to be placed in a long-term deposit
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  • 22 Transition to the Eurosystem (2) Structural adjustments to ease the transition (continued): issuance of short-term deposit for the purpose of providing collateral for euro cash issuance of 120-day tolar bills with maturities up to the end of April 2007 for the purpose of better planning liquidity by the banks
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  • 23 Slovenia in the Eurosystem Accession to the EMU: 1 Jan 2007 Introduction of the and abolition of the Slovenian tolar Irrevocably fixed exchange rate: 1 = 239.640 SIT Common monetary policy in whole euro area Final national goal: to fulfil the real convergence GDP per capita price levels structural reforms