Iran's CB Monetary Policy Is Evolving

EghtesadOnline: The Central Bank of Iran said it will implement more aspects of open market operation that involves regulating the borrowing of lenders from the CBI by obliging them to put up enough collateral when seeking funds.

News ID: ۷۵۰۱۳۷

01 June 2020

Lenders can put their excess financial resources in overnight deposits with banks at 10%, the CBI said on its website. In addition, lenders in need of liquidity will have to keep collateral with the CBI to borrow at 22%.

The CBI says this will create the interest rate corridor (IRC), which is pivotal to the CBI’s plan to target inflation at a fixed rate of 22% for the current fiscal year that ends in March 2021.

To realize its anti-inflation goals the CBI seems to have pinned much hope on the role of OMO to manage and control interest rates in the interbank market.

Referring to the authority given to it by the Money and Credit Council -- the top monetary decision-making body – the CBI said that that move was in line with its monetary policies aimed at curbing the runaway inflation.

“Besides reducing fluctuations in interbank interest rates, this will provide the CBI with new tools to manage liquidity and control interbank interest rates… which will ultimately guide interest rates in financial markets and direct inflation toward the intended target”.

OMO and the IRC are the main components of the CBI’s new monetary policy launched in January.

OMO is a financial instrument through which central banks buy and sell securities to expand or reduce money supply. The mechanism allows central banks to buy government bonds to increase the money base (cash reserves) and by extension curb inter-banking lending rates.  Selling government bonds reduces the base money and raises interbank rates.

Within this framework banks can hold bonds as collateral to borrow from the CBI.

Under the IRC structure, the CBI sets the floor and ceiling of policy rates and lets other money market rates, such as interbank rate, move within this setup.

CBI has asked lenders to allocate a portion of their assets to trade in bonds. “Given that in the new framework the CBI manages liquidity of banks and non-bank credit institutions based onIslamic bonds… they need to allot a portion of their assets to [buy] bonds,” the CBI said.

The policy is also backed by the provisions of the current fiscal budget (March 2020-21). In Note 5 of the budget law, the CBI is allowed to collateralize banks’ debts over a gradual process in a way that at least 50% of banks and credit institutions’ debts to the CBI are collateralized by debt bonds issued by the treasury.

Bond Auction

CBI started the first phase of the OMO by launching a primary interbank market for selling government bonds last week.

It seeks to boost government finances, reduce trading costs in the interbank market and facilitate access of banks and credit institutions to bonds.

The CBI is set to hold its first auction of government bonds on Tuesday. It has asked banks to place buy orders for the Murabeha bonds on the interbank trading platform.

Bonds on sale are worth 100 trillion rials ($588 million) and mature in 2023 at 15% payable every six months. Bonds are to be sold on a gradual basis in regular weekly auctions.

By organizing bond auctions the CBI wants to minimize interest rate volatility and direct it towards the rate of its choice. Regular offering of government bonds will help the CBI to realize this goal.

CBI Governor Abdolnasser Hemmati said earlier that the success of the CBI’s inflation targeting policy is contingent on adequate volume of bonds to be issued by the government.

The government is allowed to issue Islamic bonds worth 1,090 trillion rials ($6.4 billion) as per provisions of the current fiscal budget.

Unofficial reports say that it has received permission to issue 1500 trillion rials ($8.8 billion) in bonds over and above what is allowed in the budget to compensate for the omnipresent deficit spending.

Trading in government securities, repurchase agreements (repo), offering credit in return for collateral (gold, currency and bonds) and lenders’ parking liquidity with the central bank comprises the operating instruments in the CBI’s monetary policy.

Repo is a form of short-term borrowing for dealers in government securities. In case of a repo, a dealer sells government securities to investors, usually on an overnight basis, and buys it back the following day at a slightly higher price.