Journal Issue

Chapter I. Introduction

Simon Gray, and Philippe Karam
Published Date:
May 2013
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This paper represents a collection of topics on monetary policy and its implementation, including liquidity management, discussed at two seminars, held jointly between the IMF Middle East Center for Economics and Finance (CEF) and the IMF Monetary and Capital Markets Department (MCM) in Kuwait during the fall of 2011 and 2012. It embodies the seminar proceedings in its main, but the structure which draws on numerous practical applications in the Middle East and North Africa (MENA) countries will make for a useful handbook guiding policymakers in the implementation of monetary policy through an operational framework and the use of the latter in support of liquidity management and market development. The need for CBs to adapt their operational frameworks, in the face of the global financial crisis, and introduce ways to handle pressures from newly rising risks and challenges is also emphasized, including in support of financial stability and the relevant design incentive structures in the financial system. The handbook concludes with three country case studies (contributions by seminar participants) that underline the concepts and methodologies presented during the seminar, while focusing on the more recent and challenging operational issues facing their own country.

The paper starts with a detailed review of the region’s monetary regimes, which serves as a precursor to a focus on the monetary operational framework in the remainder of the paper, including: the monetary transmission mechanisms and the underlying channels in conducting monetary policy (assessing their strength and relevance); expansion of the monetary policy framework in promoting financial stability (alongside the primary price stability objective); the stance of monetary policy in the years 2009–12 following the fallout from the global financial crisis (split into oil-exporter (OX) and oil-importer (OM) countries for a more adept analysis) with an emphasis on challenges and solutions sought while working toward a broader medium-term objective which highlights the need for a consistent interaction of macro policies.

The section on monetary policy implementation focuses in particular on the factors determining the width for policy interest rate corridors. Even CBs operating a fully-credible fixed exchange rate regime need to consider how best to manage liquidity (reserve money balances at the CB) within the financial system and, ideally, promote market development with appropriate incentives. This section discusses operational differences between corridor systems which target market rates around the middle of the corridor, and those which leave rates to trade near the floor, with different consequences for monetary transmission and market development. In view of the structural excess liquidity in most of the countries represented, this section also discusses the causes of surplus liquidity and whether banks can, or should, use this to increase lending to their customers.

Focusing on the balance sheet structure of MENA CBs, as the comprehensive tool to guide the implementation of monetary policy and the support of financial stability, pertinent characteristics of country groupings are evident: large foreign exchange (FX) assets and high government deposits are dominant in oil-exporting countries over the years, whereas some countries (Egypt, Morocco, and Tunisia) have exhibited notable changes since early 2011. Pre-crisis comparison of advanced economies (AE) vis-à-vis MENA as well as AE pre-crisis and now, demonstrate some striking changes. As some MENA countries have moved from a situation of structural excess liquidity towards balance or even a structural shortage (facilitating a mid-corridor interest rate approach), many AE countries have moved in the opposite direction. Notably, Quantitative Easing (QE) means that some AE CB balance sheets are now asset-driven, and in this respect similar to some oil-exporting country CB balance sheets (asset driven, but the assets in the latter case being FX reserves).

The function of collateral underwent the same change of scope in MENA countries as in AE: pre-crisis, it mattered to ensure the financial protection of the CB in granting credit. Currently, collateral has in addition a significant financial stability function—providing CB funding for those assets with broken markets, thereby avoiding fire sales—and this has significant implications for the collateral strategy and management in terms of the range of eligible instruments, the risk management framework, and level playing field among counterparties, among others.

Another important aspect relates to the Basel III bank capital adequacy and liquidity rules. Although only one MENA country (Saudi Arabia) is part of the G20, implementation of the rules in the G20 will likely impact the banking business in the MENA countries, even if indirectly. In anticipation, the latter may want to align their supervisory frameworks with these rules, for reasons having to do for example with protecting the interest of their own financial stability or promoting own attractiveness for international market participants.

All of this will have consequences for the implementation of monetary policy in the MENA region, since CB instruments and, to a certain extent, collateral all count towards the fulfillment of the bank capital adequacy and liquidity rules. This may change the pattern of the recourse of the banks to these instruments and collateral and ultimately the transmission mechanism.

Two sections focus on specific areas of CB instruments: the maturity of instruments—in particular CB securities—used to drain structural surplus liquidity from the market; and the impact of collateral choices, and how approaches to the CB’s choice of collateral have been impacted by the global financial crisis. Common threads in the operational frameworks of MENA CBs are illustrated, using information from the IMF’s biennial survey of CB frameworks. This is followed by country case studies on Egypt, Jordan, and Tunisia.

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