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Russian Federation: Selected Issues Paper

Author(s):
International Monetary Fund
Published Date:
September 2011
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II. Improving the Monetary Operations Framework of the Central Bank of Russia 1

In the face of sharply rising inflation, the Central Bank of Russia (CBR) has tightened monetary policy against the background of welcome recent advances in ruble flexibility. However, the tightening measures taken so far have been largely ad hoc and have sometimes lacked consistency. As a result, the signals provided to the markets and the general public may have been confusing, thereby undermining the effectiveness of the measures. The recent experience highlights that a simpler and more effective framework for monetary operations is needed. The CBR is aware of the limitations of the existing framework and is seeking its reform. Against this background, this chapter suggests several improvements to the monetary policy framework that should allow for a more effective implementation of monetary policy. Moving to a consistent framework is also essential to facilitate a move to formal inflation targeting—the authorities’ medium-term goal for which preparations are ongoing.

A. Background and Motivation

1. The authorities’ general approach to monetary policy has been ambivalent. For most of the past decade, Russia’s monetary policy has tried to serve two largely incompatible objectives: low inflation and a stable exchange rate (informally, output growth has at times appeared a third goal). Where these objectives conflicted, the exchange rate objective prevailed in practice, with high and volatile inflation as a result (text figure). At the same time, the authorities’ have been preparing for the introduction of formal inflation targeting. But due to the ambivalence regarding the ultimate policy objective, the practice of monetary policy implementation has remained far removed from this goal.

2. Recent progress on ruble flexibility should allow monetary policy to focus on inflation. Encouragingly, in recent periods, the authorities have permitted a significant and progressive increase in exchange rate flexibility. Although the commitment to a flexible exchange rate policy remains to be tested in an environment that involves a sharper trade-off between inflation and nominal exchange rate objectives, in principle this development should facilitate a much-needed shift in the focus of monetary policy toward inflation control.

3. The response to the recent uptrend in inflation, however, has been haphazard and highlights key problems with monetary policy implementation. A large and structural surplus of bank reserves renders many instruments in the CBR’s monetary policy toolbox presently ineffective. Partly as a result, recent CBR tightening attempts have been largely ad hoc and focused on secondary instruments (the deposit rate and reserve requirements) with only a limited role for its main policy rate. This practice makes for distorted policy signals and is not likely to be effective at achieving the CBR’s inflation objectives. The experience highlights the need to come to a simpler and more effective framework for monetary operations.

Sources: Federal Statistics Office; Haver, and IMF staff calculations.

4. Aware of the issues, the CBR is seeking to reform the monetary operations framework. The authorities recognize the limitations of the current framework and intend to simplify and rationalize it, including with a view to preparing for the envisaged move to inflation targeting.

5. This chapter suggests improvements to the operational framework, which would promote a more effective policy implementation. The chapter builds on the technical assistance that the IMF has provided to Russia during the past five years, and provides specific recommendations that can be implemented now.2 The recommendations are aimed at the implementation of monetary policy in normal times. Liquidity management during periods of financial stress falls outside the scope of this chapter and is the subject of separate work undertaken in the context of the 2011 Financial Sector Assessment Program (FSAP). The chapter is organized as follows. Section B provides a brief overview of the current framework and section C highlights its main problems. Then, section D discusses several recommended improvements and section E offers an outline of how the improvements could be phased in while simultaneously tightening monetary policy. Finally, section F briefly discusses means to deal with the potential challenge of capital inflows.

B. The Current Framework

6. The CBR uses a large set of monetary policy instruments. The authorities’ framework for the implementation of monetary policy is extensive and complex. The CBR employs a relatively large number of standing facilities (SF), at various different interest rates, and for a wide range of maturities (O/N to 30 days, text table). It maintains a similarly wide variety of instruments for open market operations, including repos, Lombard loans, government securities, central bank notes (OBRs), and FX sales and purchases. Separately, the CBR also uses changes in reserve requirements as a short-term instrument to control market liquidity. And the CBR manages deposit auctions on behalf of the Ministry of Finance, which also affect liquidity.

Monetary Policy Instruments of the CBR(as per June 1, 2011)
PurposeTypeInstrumentTermInterest rateFrequency
Provide liquidityOpen Market OperationsLombard Auctions7 days-3 monthsSet by auctionWeekly
Direct Repos1, 7, 90 days; 6, 12 monthsSet by auction 1/Daily
Purchase of OBRs or government securities--As needed
Purchase of FX--As needed
Standing FacilitiesCreditsIntraday0Continuous
Overnight8.25%Continuous
Lombard Loans1-30 days6.75%Continuous
FX swaps
Absorb liquidityOpen Market OperationsDeposit Auctions4 wks, 3 mtsSet by auction 1/Weekly
Sale of OBRsup to 6 monthsSet by auctionAs needed
Sale of government securities--As needed
Sale of FX--As needed
Standing FacilitiesDeposit OperationsOvernight (T+0)3.50%Continuous
Tom-next (T+1)3.50%Continuous
Spot-next (T+2)3.50%Continuous
1 week (T+0)3.50%Continuous
Spot-week (T+2)3.50%Continuous
Demand (call)3.50%Continuous

Minimum and or maximum rates apply

Source: Central Bank of Russia

Minimum and or maximum rates apply

Source: Central Bank of Russia

7. The policy interest rate corridor is relatively wide. With the overnight deposit rate currently at 3.5 percent and the overnight refinancing rate at 8.25 percent, the spread between the lowest and the highest rate in the CBR’s policy rate corridor is 475bp. While this is considerably narrower than a few years ago—when the difference exceeded 1000bp—the corridor is very wide compared to that in countries with well-functioning frameworks. For instance, the corridor is 200bp wide in the euro area, the UK (pre-crisis), and Hungary, 100bp wide in Norway, Sweden, New Zealand, Indonesia, Thailand and South Africa, and 50bp wide in Australia, Canada, and Malaysia.

8. The refinancing rate is used as the reference rate for the monetary policy stance. The interest rate on overnight credits under the CBR’s standing facility—the refinancing rate—is routinely referred to in CBR policy communications as the headline policy rate, and thought to be indicative for the overall stance of monetary policy.

9. Reserve requirements are at a low level, and not binding. Following three recent increases, reserve requirement ratios are 4 percent for banks’ liabilities to domestic parties and 5.5 percent for liabilities to corporate nonresidents. At these levels, however, required reserves remain lower than they were pre-crisis (5.5–8.5 percent) and not high by international standards (text table). Also, for the system as a whole, the rates are nowhere near being binding: at end-June 2011, required reserves accounted for less than 20 percent of the funds held by the banks at the CBR. Vault cash is counted toward the reserve requirement, and monthly averaging is allowed over 60 percent of the reserve balance. Required reserves are unremunerated.

10. The differentiation of the reserve requirements is designed to deter potential capital inflows. As the recent increases in reserve requirement ratios have been asymmetric, the CBR reintroduced differentiation between the reserve requirements pertaining to liabilities of residents and those of nonresidents. This measure was motivated by the wish to (preemptively) discourage any speculative capital inflows that might follow from recent increases in oil prices. The differentiation was also present in Russia before the crisis.

Required Reserve Ratios in Emerging Economies
CountrySingle ratioRange of ratiosComments
LowerUpper
Argentina0.0020.00Average = 15.67. Demand deposits and savings accounts = 19% (20%) for local currency (FX); Time Deposits (30-60 days) = 11% (15%); Time Deposits (90-180 days) = 2% (5%); Time Deposits (180-360 days) = 0% (2%)
Brazil*4.0042.00
Chile6.60
China*14.0016.00
Colombia0.0011.0011% Checking Accounts, Sight Deposits and Savings Accounts; 4.5% CD and bonds with maturity <=18 months; 0% CD and bonds with maturity > 18 months
Hungary2.005.00As of November 2010, the Central Bank allows banks to choose what reserve requirement ratio they want from a range of 2%, 3%, 4%, or 5%. The goal is to facilitate bank liquidity management.
India6.00Raised April 2010 from 5.75
Indonesia*1.007.50
Israel0.0010.00As of janurary 27, a 10 percent reserve requirement will apply to NIS/foreign exchange swap transactions (FX Swaps) and NIS/foreign exchange forwards.
Malaysia1.00
Mexico0.00
Peru9.0060.00The minimum unremunerated stands now at 9 percent. The marginal stands at 25 percent for domestic currency deposits of residents and 120 percent for non-residents deposits. The marginal reserve requirement for FX deposits is currently 55 percent. The reserve requirements on FX foreign liabilities with maturity less than two years is currently at 60 percent (reduced from 75 percent in January).
PolandThe (upper) RRR was raised in January, 2011, by 50 bps. The previous 3.0 percent rate was held since
0.003.50July, 2009.
Russia4.005.50RRs on liabilities to corporate nonresidents are at 5.5 percent, while RRs on the other liabilities are 4 percent.
South Africa2.50The effective percentage held varies but is somewhat lower because banks are allowed to exclude certain liabilities from the base amount.
Thailand6.00
Turkey5.0012.00Local Currency (5-12 percent) depending on maturity, since Jan 2011.
Source: National Authorities

Data from MCM’s “Information System for Instruments of Monetary Policy”

Source: National Authorities

Data from MCM’s “Information System for Instruments of Monetary Policy”

11. The CBR issues short policy statements on a monthly basis. The schedule of CBR Board meetings at which monetary and interest rate policy are discussed is broadly known to the public (meetings take place at the end of each month). Following each of these policy meetings, the CBR issues a short policy statement that communicates the Board’s view on recent monetary and economic developments and the prospects for inflation, and announces any key policy decisions taken, together with a concise motivation.

C. Problems with the Current Framework

12. The money market is highly segmented and not effective at redistributing liquidity across the system. With an unsecured deposit market that only includes the 20 largest banks (out of a total of about 1000 banks), and with collateral constraints weighing heavily on the scope for trading with and among the many smaller banks, the interbank market is fragmented and not effective at playing its normal role in liquidity redistribution. As a result, the CBR simultaneously lends to and borrows from the banking system, and the interbank market interest rate has been prone to volatility even in the face of net liquidity surpluses for the system as a whole. The fragmentation of the Russian money market is a problem because a more unified and liquid money market would better transmit monetary policy signals to other markets and to retail interest rates. Having a well-functioning money market is thus important for an effective implementation of monetary policy.

13. The set of monetary policy instruments is convoluted and overly large. With more than 20 different windows, encompassing a wide range of maturities and interest rates, the CBR’s set of instruments is sprawling and complex. This complexity obscures the monetary policy stance, including because the relative importance of the different individual instruments varies according to circumstances. The segmented approach to liquidity management is also not conducive to a proper functioning money market. While, arguably, the large number of different CBR facilities is itself the reflection of the fragmented state of the money market, the many instruments also facilitate and reinforce this fragmentation since they reduce—or even eliminate—the incentives for banks to trade among themselves.

14. The wide corridor promotes interest rate volatility and discourages interbank trading. While there is no established way to determine the optimal width of the interest rate corridor, Russia’s current 475bp spread would seem too wide. Having too wide a corridor has considerable downsides. In particular, it provides scope for high interest rate volatility, which has been a significant problem in Russia in recent years (even though rates have been more stable during 2010). Such volatility distorts the policy signal and thus reduces the effectiveness of monetary policy. Also, a large spread between deposit and lending rates will lead banks to be very conservative in the use of reserve funds, since the cost of running short is high. As a result, an overly wide corridor tends to discourage interbank trading, thus hampering the proper function of the interbank market.3

15. Policy interest rates provide confusing information about the policy stance. Interest rates on the various CBR instruments are often changed independently, without implications for the other rates in the policy rate corridor (e.g., in December 2010, overnight deposit rates were raised while other rates were left unchanged, and in February 2011 the refinancing rate and selected deposit rates were raised, but Lombard loan rates and some repo rates were not adjusted). As a result, despite the CBR’s consistent reference in its policy statements to the “refinancing rate” as its main policy rate, in practice the framework suffers from a lack of clear signaling instruments.

16. The “refinancing rate,” the CBR’s headline policy rate, is not binding. Like several other countries, Russia faces a situation of surplus reserve balances with the banking system (text figure). This structural liquidity surplus is the result of unsterilized foreign reserve accumulation and, in recent years, the monetization of fiscal deficits. The structural reserve surplus significantly weakens the effectiveness of the CBR’s interest rate policy. Since the banks’ excess reserves typically exceed the amount they need for transaction purposes, the liquidity surplus makes that there is effectively no marginal demand for CBR money. Under these circumstances, the CBR’s lending rates do not have traction, and it is instead the deposit rate that is often the binding rate in the system as banks deposit their excess funds at the CBR. Consequently, the interbank market rate tends not to align with the refinancing rate, the official target. Rather it tends to fluctuate in the bottom half of the corridor, and in recent periods it has aligned almost perfectly with the CBR deposit rate (text figure).

Bank Liquidity

(Stock, billions of Russian rubles)

Source: Central Bank of Russia.

Overnight Interbank Rate (MIACR) and CBR Standing Facilities

(percent, weekly average)

17. Reserve requirements are changed frequently, contributing to uncertainty about the policy stance. Required reserve ratios have been changed frequently in previous years in apparent attempts to affect bank liquidity with a short- to medium-term horizon. Reserve requirements are thus being used as a substitute for open market operations, which may be a more precise and effective instrument to effect such changes (see below). Reserve requirement changes are also seemingly used to implement tightening or loosening of the monetary policy stance—in combination with, and sometimes instead of, policy rate changes—which contributes to confusion regarding what the CBR’s main effective policy instruments are, and what the overall stance of monetary policy is.

D. Improvements to the Framework

18. More coherent implementation of monetary policy would increase its effectiveness. As highlighted in the previous section, the existing monetary operations framework is ill equipped to steer key market interest rates and deliver clear signals about the stance of monetary policy to the markets and the general public. Improving the operations framework is therefore important for a more effective monetary policy implementation and for successful inflation control. This section offers recommendations for improvements to the framework and monetary policy implementation. The recommendations build on the practice in various advanced economies and some emerging markets that are generally considered to have well-functioning systems.

Policy instruments

19. Rationalizing and streamlining the set of policy instruments would enhance transparency. As recommended in previous IMF technical assistance reports, instead of using a large variety of multiple duration instruments to manage liquidity conditions and a large set of standing facilities with different interest rate conditions and maturities, the CBR should narrow the set of instruments and focus its interest rate signal unmistakably on one short-term instrument. Longer-term instruments could still be used, but only for structural liquidity adjustments and these operations should be conducted at market rates, thus moving away from maximum or minimum rates. The IMF 2008 report made specific recommendations as to how to simplify and rationalize the set of monetary instruments which are summarized in Annex 1. While a few of these recommendations seem to have been implemented since, new differentiations in instruments have been added and considerable scope for further streamlining remains.

20. Eliminating niche instruments would also foster money market development. The many different facilities in the current framework effectively accommodate and entrench the fragmentation of the interbank market since they encourage banks to rely for their liquidity management on the CBR, rather than on other banks. Reducing the number of specific facilities is therefore key to providing incentives for the development of the market. Complementary initiatives to develop the money market could help capitalize on these improved incentives and facilitate the transition (see forthcoming Financial Sector Stability Assessment and accompanying documents).

Policy interest rate and the corridor

21. A narrower corridor would help limit interest rate volatility and promote interbank trading. As highlighted in the previous section, Russia’s current 475bp spread seems too wide in light of the relatively high interest rate volatility (in the pre-crisis period) and the lack of interbank activity. To improve incentives for banks and increase the effectiveness of policy signals, the CBR should aim to gradually reduce the width of the corridor to a spread of no more than 200bp, a width that is consistent with that in countries with more advanced frameworks and well-functioning markets. Depending on experiences with this spread, further adjustments (in either direction) may be considered over time.

22. Switching to a relevant policy target would allow for a better communication of the monetary policy stance. The current situation in which the official policy rate is at 8.25 percent, while the operating target—the O/N interbank market rate (MIACR)—hovers around 3.5 percent is undesirable as it makes for a highly distorted policy signal. Indeed, for communication purposes, it is preferable that the announced policy rate bears close relationship to the targeted market rate. It is unclear that the overnight refinancing rate can fulfill this function in a system that tends toward having surplus liquidity. Although, alternatively, the deposit rate could conceivably be used to steer market rates under these circumstances—as it effectively is at present—it is less straightforward how the transmission via the deposit rate affects the economy. Also, when steering the market rate through deposit operations, the funds remain fully liquid which carries the risk of compounding any pressures on the exchange rate in situations where depreciation fears take hold, thus contributing to exchange rate volatility.

23. A policy rate at the center of the corridor would provide for an optimal transmission. Better than having the policy rate set at either of the SF rates is to announce a target for the interbank rate that is broadly in the center of the prevailing interest rate corridor, and to aim at conducting open market operations (OMO) at this rate. The benefit of steering the target market rate toward the middle of the corridor is that at that point market liquidity will be broadly in balance (with minimum resort to the CBR’s standing facilities), which is conducive to interbank trading and reliable market price formation, thereby providing for an optimal transmission of the monetary policy signal.

24. Surplus liquidity needs to be drained to make the policy rate binding. Once an interest rate target (henceforth “the policy rate”) has been established, the CBR would need to drain surplus reserves from the system until the market rate has reached the target level. Note that this may not be a gradual process. Indeed, the initial liquidity absorption is likely to have only very limited effect on market rates, while at the end of the process—when liquidity constraints become binding—the adjustment could be sharp. To drain liquidity, the CBR can use the various OMO instruments in its arsenal including repos, OBRs, and foreign exchange transactions, while, at the margin, reserve requirements may also help (see below). Absorbing the liquidity surplus is essential to establish some positive demand for central bank reserves and to create a situation in which the central bank’s lending rates become relevant, which facilitates the effective implementation of monetary policy.

25. Reducing liquidity will come at a cost to the CBR. It needs to be realized that the draining of liquidity will involve a (likely significant) cost for the CBR because it will have to pay higher rates on the OMO instruments than it currently pays on deposits. While this cost should be set against the benefits in terms of monetary policy effectiveness, to avoid unwelcome surprises, the future losses should be calculated in advance and the long-term implications for the CBR balance sheet should be properly assessed. The costs to the CBR of reducing excess reserves could be lower to the extent that the government would effectively help absorbing liquidity through the issuance of ruble-denominated debt. Thus, CBR operations would need to be closely coordinated with the Ministry of Finance.

26. To ensure a consistent policy signal, all CBR rates should move in lockstep. Once the corridor has been narrowed to the desired width, any change in the policy rate should be accompanied by immediate corresponding changes to the interest rates on the standing facilities, so that the desired width of the corridor is maintained and all interest rates in the corridor provide the same policy signal. A useful way of automating this practice—used by many countries with corridor systems—is by defining the interest rates on the standing facilities in terms of spreads relative to the policy rate. Thus, assuming a 200bp corridor, the deposit rate would be set as the policy rate minus 100bp, while the refinancing rate is set as the policy rate plus 100bp.

Reserve requirements

27. Reserve requirements should not be used to effect incremental changes in the monetary stance. While reserve requirements directly affect bank liquidity and could in principle be used to effect changes to the monetary policy stance, in practice such use has significant drawbacks. In particular, it is difficult to estimate the impact of changes in reserve requirements as each change will affect individual depository institutions in different ways, depending on each institution’s deposit base. By the same token, reserve requirement changes can also be more disruptive. For these reasons, open market operations (such as repo auctions) are generally considered as a preferable and more precise tool for liquidity management. In most advanced systems, reserve requirements are changed rarely, if at all.

28. They could, however, be raised structurally by a small amount. At 4–5½ percent, the reserve requirement ratios in Russia are not very high, and from this perspective there may be some scope to raise them in a structural manner (i.e., on a permanent basis). This could help, at the margin, with absorbing the structural liquidity surplus in the system. However, it must be realized that the reserve requirement cannot do all the heavy lifting in terms of liquidity absorption. In particular, given the current huge amount of excess reserves in the system, reserve requirements would need to be raised to very high levels before sufficient impact would be felt. Such high reserve ratios—assuming that they would remain unremunerated—would effectively act as a heavy tax on the banking system, which would stifle long-term financial sector development and impose a high cost on the economy. In addition, reserve requirements are a relatively inflexible instrument and should not be set too high since this may cause a need for (frequent) future changes if liquidity conditions change. For these reasons, it is preferable to raise reserve requirements by a moderate amount—say, 1–2 percentage points—and to rely on open market operations to drain the remaining excess reserves. Barring exceptional circumstances, (see section V), reserve requirements should not discriminate between residents and nonresidents.

Communication

29. The CBR’s communication practices could be further improved. The CBR’s recent practice of issuing short statements after its monetary policy meetings is commendable and should be continued. To optimally support interest rate policy, it is important that the policy statements are sufficiently candid and timely in conveying concerns about inflation, so as to build credibility and prepare the public for impending policy actions. Thus, the situation that occurred in late 2010, when the CBR policy statements were sanguine on the inflation outlook up to the moment that actual tightening began, should be avoided. To further support the CBR’s policy communication, it would also be useful to start publishing information on inflation expectations, and to publish the CBR’s medium-term inflation forecast. Such information will help the public understand the context of policy decisions. It will also reinforce the message that the main focus of monetary policy is on inflation.

E. Upgrading the Framework while Tightening Policy

30. Improvements to the framework and monetary tightening can be implemented simultaneously. As noted at the outset of this chapter, Russia currently faces two separate but closely related challenges: first, rising inflation and a corresponding need for monetary tightening, and second, the need to improve the monetary operations framework to increase the effectiveness of monetary policy. The two issues can, and should, be addressed in parallel because a more effective operations framework would greatly enhance the CBR’s capability to organize a coherent and adequate policy response to the increasing inflationary pressures. The precise sequencing of measures deserves attention.

31. A plan of action could involve the following steps, to be completed in a 6–12 month timeframe. The steps provide an example of what the transition to an improved framework and a simultaneous policy tightening could look like. Note, however, that the precise timing and modalities of each step will depend on circumstances (which may change along the way), and that the degree of tightening that the steps involve would need to be commensurate with the inflation outlook.

  • Step 1. Plan and communicate carefully. At the outset, it is important to decide on a detailed strategy as to how to phase in the changes to the framework, to avoid policy uncertainty and volatility. While the strategy needs to be flexible enough to adapt to changing circumstances (e.g., with respect to the degree of monetary tightening), the main outline of the plan needs to be agreed in advance, and supported by the main relevant policy makers. Once the strategy has been determined (which should be a matter of weeks, not months), the CBR needs to prepare the banks, the markets and the public by carefully communicating the (thrust of) the intended changes and the envisaged timeline.
  • Step 2. Start draining liquidity without delay. The CBR should start with draining excess reserves via increased repo operations and/or OBR issuance at market rates. Mopping up the existing amount of excess reserves may take some time. This is because banks need to adjust and reorganize their own liquidity management in response to the change in CBR policy, and therefore need to be granted a reasonable transition period—3 to 6 months should be sufficient—during which the higher volume of CBR open market operations is phased in. Given that it will take some time before the draining of reserves will reach its full envisaged effect, it is important to start draining liquidity soon and to gradually but decisively step up open market operations in the months ahead. At this time, the CBR could also start retiring redundant facilities and streamlining the set of policy instruments.
  • Step 3a. Raise deposit rates substantially. While the increasing open market operations are starting to drain liquidity, the deposit rate will likely remain the binding rate in the system for some time. To effectuate a monetary tightening during this period, the deposit rate should be raised. This could probably be done in fairly large steps of 50–75bp each. This policy would simultaneously serve to help narrow the corridor towards the desired 200bp.
  • Step 3b. Raise refinancing rate to clearly signal tightening. During the first phase of the policy tightening it is also important to raise the refinance rate as this provides the clearest signal to the public that the CBR is embarking on a tightening cycle. In order not to undermine the efforts to narrow the corridor, however, the increases in the refinance rate should be appreciably smaller—say, 25bp—than the increases in the deposit rate. In any event the increase in the refinance rate will be mostly symbolic at this point as the rate will remain not binding during this phase.
  • Step 4. Raise reserve requirement (optional). If it is decided that the required reserve ratio should be raised structurally, this would also best be done early on because of its implications for the amount of open market operations needed to eliminate the remaining liquidity overhang. Depending on the desired level of reserve requirements and the precise timing of the increase, the transition could be broken up in a few smaller steps, if needed to allow banks sufficient time to adjust.
  • Step 5. Announce new policy rate. Once excess reserves have been drained to the point that the interbank market rate aligns with the OMO rate, the CBR would announce a new policy target—effectively equal to the OMO rate—to replace the refinancing rate as the “signaling” policy rate in the monetary policy framework. Since the new policy rate would be lower than the refinancing rate, the technical nature of the change should be communicated clearly to the public so as to avoid the possible perception of policy relaxation. Any further tightening (or loosening) of monetary policy from here would be effected by raising (lowering) the new policy rate, and conducting OMO as needed to align the interbank market rate with the newly announced policy target.
  • Step 6. Complete transition to narrow corridor. To the extent that the corridor width at this point would continue to exceed 200bp, the refinancing and deposit rates should now be further adjusted so that they are set 100bp above and below the policy rate, respectively. Such changes would again be largely technical in nature, and this should be communicated clearly. Any subsequent changes in the policy rate would from now on be accompanied by corresponding changes to the SF rates so that the width of the corridor is maintained at 200bp.

F. Complementary Policies: Dealing with Capital Inflows

32. Higher interest rates may have the effect of attracting capital inflows. Although Russia has not experienced significant capital inflows in the post-crisis period, it is conceivable that a tightening of monetary policy would, at some point, elicit renewed capital inflows. If such inflows were to be sizable, they can pose a significant policy challenge since they have the potential of fueling credit and inflation (as in the pre-crisis period), thereby ultimately undermining the effectiveness of monetary policy.

33. But monetary policy should focus on inflation, not on managing capital flows. In the face of rising inflationary pressures, keeping policy rates low to discourage capital inflows is not a viable policy option as this will eventually result in high inflation. It is therefore key to use other policy tools to effectively address capital flow issues, so as to make room for monetary policy to focus squarely on inflation control.

34. Exchange rate flexibility and fiscal policies and are best placed to address inflows. The first line of defense against renewed capital inflows should be to allow the exchange rate to adjust freely. Greater exchange rate flexibility should help discourage speculative inflows and contain inflation. Beyond this, an appropriate macroeconomic policy mix geared to containing domestic demand is also key. In this context, with monetary policy focusing on inflation, fiscal policy should be the main tool for mitigating pressures on the real exchange rate in the face of rising oil prices—that is, it will need to be sufficiently countercyclical to do so.

35. Other complementary policies may also be needed. In particular, prudential regulations should be shored up to limit the risks of credit booms. This could include counter-cyclical regulatory requirements, restrictions on foreign currency lending, and differentiated reserve requirements (preferably by currency or maturity, not residency) to reduce currency and maturity risks. Improved supervision will also be key—this implies the need for greater powers for the central bank to supervise not only banks, but also their affiliates.

36. In certain circumstances, capital controls might be considered, but these are no substitute for an appropriate macroeconomic policy response. In an environment of surging capital inflows, standard macroeconomic and prudential tools may not be sufficient or appropriate. For example, an excessive appreciation of the exchange rate could damage competitiveness. Reserve accumulation can be costly, and—if not sufficiently sterilized—can stoke inflation. And a strong fiscal position, particularly if accompanied by low public debt and robust international reserves, can perversely end up attracting even greater inflows. In such an environment, capital controls may be a legitimate component of a broader package of policies responding to surges in capital inflows. However, controls are not a panacea—they can be difficult to enforce (especially outside the banking system), they can be circumvented, and their effectiveness is unclear. Moreover, they cannot serve as a substitute for appropriate macroeconomic policies and reforms that allow the economy to respond more flexibly to the impacts of sustained capital inflows.

Annex I
Russia: Monetary Policy Instruments of the Central Bank of Russia—Suggested Simplification
TypeTermRateMechanismPeriodicity
OMO+Overnight6.5 percent (=Repo (FX swap if collateral is tight)Daily
7 daysPolicy rate)Collateralized credit (Lombard; Lombard list collateral only)Weekly
OMO+OutrightMarket ratePurchase of foreign currencyAs needed
OMO+7–28 daysMarket rateMoF deposit auction Minimum rate of Policy rate plus 100 bps as uncollateralizedAs needed
OMO-28 daysMarket rateDeposit auctionsWeekly, or As needed
OMO-Up to 6 monthsMarket rateBank of Russia bonds (OBRs)Weekly or less often
OMO-OutrightMarket rateSale of government securities or foreign currencyAs needed
SF+Intraday0%Lombardpermanent
SF+Overnight or 7 daysPolicy rate +200 bpsRepo, FX swap or Lombard; Policy rate +400 bps in the case of intraday credit which is not repaid on timepermanent
SF+28 daysPolicy rate +250 bpsLombard; 100 bps add-on for collateral not on the Lombard listpermanent
SF-OvernightPolicy rate -300 bpsDepositpermanent
Source: IMF (2008), Russia—The Collateral Framework for Central Bank Operations.
Source: IMF (2008), Russia—The Collateral Framework for Central Bank Operations.
References

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1

Prepared by David Hofman. The author thanks Simon Gray (MCM) for helpful discussions and suggestions.

2

For useful general discussions of the various aspects of monetary operations, see Bindseil and Jablecki (2011), Borio (2001), Gray (2011), Gray and Talbot (2006), and Kahn (2010).

3

It should be noted that, of course, too narrow a corridor may ultimately also discourage interbank trading—as the benefits become too small—and may result in the central bank unduly intruding in normal interbank market activity. Thus, determining the right width of the interest rate corridor is something of a balancing act.

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