Abdolnasser Hemmati, the CBI boss, in a note Friday said the regulator is trying to steer interbank rate to the determined target.
"Given the decline in inflation expectations… and no need for raising interest rates, the CBI plans to navigate interest rates to the middle of the interest rate corridor [IRC]," he wrote in a note posted in his Instagram account.
IRC is a system for guiding short-term market interest rates towards the central bank’s target/policy rate. It is a rate at which central banks lend to banks (typically an overnight lending rate) and a rate at which it takes deposits from them (deposit rate).
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.
On a staged basis, the lower bound of IRC rose from 10% in May 2020 to 14% at present. The upper bound was set at 22% but it went up as high as 23.2% in October. It declined to 20.7% in late November.
The senior banker said the interbank rate declined further to 19.7% this week. The CBI controls interbank market by regularly implementing open market operation, launched more than a year ago as part of the CBI's monetary policy to control inflation, regulate interbank rates and improve management of money supply.
Hemmati pointed to the role of the repurchase agreement (repo) mechanism to drive interbank interest rate lower.
As a component of the OMO, repo is a form of short-term borrowing for dealers in government bonds. 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. Repos are typically used to raise short-term capital.
Monitoring Banks Balance Sheets
The banker added that high interest rates in the interbank market expose weak balance sheets of banks. "As a matter of policy, the central bank seeks to enforce plans that prevent expansion of banks' balance sheets," he wrote. The regulator earlier announced plans to monitor the balance sheets at regular three-month intervals.
Investment in non-bank activities, increase in bank spending, expanding branches and buying fixed assets are among the activities the CBI wants lenders to desist.
The regulator says it is positive about improving balance sheets of lenders resulting from capital increase and purchasing government bonds. Accordingly, the CBI says it will impose tougher restrictions on lenders with poor financial performance.
Harbinger of Declining Inflation Expectation
Hemmati took stock of monetary reports saying that change in the composition of money supply in the previous calendar month (ending Feb.18) also indicates a decrease in inflation expectation.
He pointed to the decline in the share of money (M1) in the twelve months ending Feb.18 and a proportional increase in the share of quasi money as a corroborating signal that money had been circulating with less velocity in the economy.
Annualized M1 growth stood at 56.9% and M2 increased 35.3% in the mentioned period. In the month to October 21, M1 growth in the course of twelve months was 88.6%. It declined to 63.8% in the month to January 19. M2 grew 28.1% in the year ending Oct. 21 and rose 34.3% by Jan.19.
M1 is composed of physical currency and coins, demand deposits, travelers' checks, other checkable deposits and negotiable order of withdrawal (NOW) accounts. M2, also called near-money, refers to less liquid assets that can be quickly exchanged for cash. Examples are bank certificates of deposit and treasury bills.
Despite concerted efforts to control money supply, it has grown in recent months due mainly to government budget deficits and the US economic blockade. Broad money supply reached 31,300.2 trillion ($125 billion) at the end of third quarter of the current fiscal year on Dec. 20 -- up 38.4% year-on-year.