Hemmati: OMO Pivotal to Stem Inflation

EghtesadOnline: The governor of the Central Bank of Iran says the main function of the open market operation is to help fight inflation by regulating short-term interest rates in the interbank market.

News ID: ۷۴۷۴۹۴

08 June 2019

In an Instagram post Thursday, Abdolnasser Hemmati said the soon-to-be implemented plan is key in that [ absence of OMO] the CBI has not been able to sustainably curb inflation by controlling the money supply and overseeing the balance sheets of banks.

OMO is a financial instrument through which central banks buy and sell securities in the open market to expand or reduce money supply.

In the framework of OMOs, central banks buy government bonds to increase the money base (cash reserves) and by extension curb inter-banking lending rates.  By the same token, selling government bonds decreases the base money and raises interbank rates, according to Financial Tribune.

“By launching OMO the CBI does not seek to implement an expansionary monetary policy, rather it wants to fundamentally redefine monetary policy,” he wrote.

Expansionary policy is a form of monetary policy that seeks to encourage economic growth or combat inflationary price increases by expanding the money supply faster than usual or lowering short-term interest rates.

Transmission mechanism of monetary policy is the process through which monetary policy decisions affect the economy in general and price levels in particular. Such decisions are intended to influence the aggregate demand, interest rates, and amounts of money and credit in order to affect overall economic performance.

Hemmati said the OMO will reduce discount rates -- the minimum interest rate set by the CBI for interbank lending -- as rates vary within a specific range set by the regulator.

“Because the CBI was not allowed to trade in government bonds in the past, the rate of bonds used to be determined by market participants…this involved some costs pertaining to discount rate.”

Earlier in April, the Money and Credit Council – a major monetary decision-making body - approved the implementation of OMO.

The policy was endorsed as part of the CBI’s plan to implement new instruments in its monetary policy, regulate interest rates, curb inflation and develop a regulated framework for controlling banks’ borrowings from the CBI.

The CBI chief said availability of government bonds is a precondition for launching OMO because without purchasing bonds, no money would be lent to banks.

However, he emphasized that this doesn’t mean an obligation on the government to issue bonds. “The government issues bonds based on its budgetary requirements.”

Economists and stakeholders say the market for government-issued securities is robust for launching the OMO because the government issued a bulk of securities in the past and plans to do the same this fiscal year (started March 21).

According to a Majlis Research Center report in January, adding up bonds that mature in the current fiscal (March 2019-20) (270 trillion rials/$2.1 billion) and the total bonds to be issued in the current year (910 trillion rials / $7.5 billion), as mentioned in the current budget, there should be enough bonds in the market for the effective implementation of OMO.

As per the budget, “in order to implement monetary policies and control interest rates and inflation, the CBI will launch the OMO and trade in Islamic bonds issued by the government. Banks can hold bonds as collateral to borrow from the CBI.”

Hemmati reiterated that in tandem with OMO, the CBI is striving to correct banks’ balance sheets to be able to contribute to economic stability and decent growth rates.