Challenges for the Central Bank in exerting influence on short-term interest rates (the case of Ukraine) Volodymyr Lepushynskyy National Bank of Ukraine

Brief macroeconomic overview Sufficient (but volatile) GDP growth for the last 7 years; Volatile and high inflation generates unpredictable business environment; Economy has high level of openness.

Former monetary regime Ukraine had been using uncommon kind of monetary regime: announcement of 4 targets in MP Guidelines; de-facto peg vis-à-vis the US dollar with commitment to achieve pre-specified level of money growth; insufficient role of an interest rate policy.

Former monetary regime Consequences Positive: economic stabilization after long period of hyperinflation and financial crisis; credibility to monetary authority; accumulation of reserves. Negative: ineffective control of the inflation; underdeveloped domestic market; exposure to a risk of speculative attack; high level of dollarization.

New monetary regime adoption of inflation targeting in the future prospect; gradual move towards flexible ER; increasing role of interest rate policy.

Theoretical background Exerting influence on short-term interest rates Interest rates corridor Interest rates corridor Key interest rate Key interest rate Interest rate – operating guide Interest rate – operating guide  usually interest rate on a main instrument (refinancing/mobilization);  signals the stance of the market;  differs from operating guide (normally – one-two weeks’ maturity)  pegged to the key interest rate;  the highest level of the interest rate – interest rate on refinancing, the lowest – interest rate on mobilization;  key interest rate is in the middle of the corridor;  maturity coincides with operating guide  has maturity up to 3 months (overnight is the most frequent)

Theoretical background Key interest rate selection disadvantages key interest rate is an interest rate on mobilization operation key interest rate is an interest rate on mobilization operation key interest rate is a refinancing interest rate key interest rate is a refinancing interest rate  implementing monetary policy is inactive;  Large inflows of short-term fund (hot capital) from abroad is possible  liquidity position is unstable (results from external factors)

Ukrainian experience Insufficiently effective adjustment in short-term interest rates Insufficiently effective adjustment in short-term interest rates Present model of monetary policy contradicts implementation of common model of interest rate policy consequences of regime regime characteristic regime characteristic uncommon approach to MP uncommon approach to MP de-facto pegged regime interest rate is not used as an operating guide interest rate is not used as an operating guide interest rate is not a main instrument of monetary policy interest rate is not a main instrument of monetary policy

Ukrainian experience Insufficiently effective adjustment in short-term interest rates Insufficiently effective adjustment in short-term interest rates initial conditions discount rate does not play a key role discount rate does not play a key role ineffective interest rates corridor (overnight) ineffective interest rates corridor (overnight)  real operation is not put into practice by a discount rate;  legislative definition of a discount rate is not equal to its usage  maturity terms of corridor rates was unstable  changes of the ceiling and floor rate of the corridor are unsynchronized and not necessarily linked to changes in a discount rate;  refinancing mechanism conditioned to the requirements of prudential supervision.

Ukrainian experience Interbank market of Ukraine

Ukrainian experience Improvement of Central Bank’s influence on short-term interest rates Improvement of Central Bank’s influence on short-term interest rates satisfied conditions Improvement in the approach to monetary strategy Improvement in the approach to monetary strategy Improvement of instruments regulating banking liquidity Improvement of instruments regulating banking liquidity  priority of price stability in perspective;  moving towards greater exchange rate flexibility;  rejection of setting target of monetary aggregates  overnight refinancing/mobilization with daily frequency;  refinancing/mobilization with weekly frequency and maturity of 14 days;  minimization of prudential requirements for refinancing mechanism

Ukrainian experience Implementation of interest rate corridor

Ukrainian experience Improvement of Central Bank’s influence on short-term interest rates Improvement of Central Bank’s influence on short-term interest rates conditions should be satisfied  discount rate is a key interest rate – the highest/lowest level of interest rates on 2 weeks’ refinancing/mobilization;  interest rate on refinancing/mobilization changes generally in the same time and in the same direction;  discount rate and interest rate on 2 weeks’ refinancing/mobilization is in the middle of the overnight corridor  increasing activity of transactions with Government bonds on the open market;  restructuring Government debt to the National Bank in liquid Government bonds;  developing Government bonds market (primary dealer, strengthening clarity of Government action) improvement of interest rate setting for the National Bank operation improvement of interest rate setting for the National Bank operation improvement of structure liquidity management mechanism improvement of structure liquidity management mechanism

Ukrainian experience Improvement of Central Bank’s influence on short-term interest rates Improvement of Central Bank’s influence on short-term interest rates IMPOSSIBILITY OF IMMEDIATE APPLICATION OF NARROW OVERNIGHT CORRIDOR reason conditions should be satisfied for initial stage conditions should be satisfied for initial stage high level of discount rate (result from CPI) constrains ceiling of corridor high level of discount rate (result from CPI) constrains ceiling of corridor low interest rate on the inter bank market (result from large liquidity) constrains floor of corridor; low interest rate on the inter bank market (result from large liquidity) constrains floor of corridor; results in  avoiding inter bank shock;  avoiding unreasonable expenses of mobilization operations wide and asymmetrical corridor of overnight interest rate unrelated to discount rate wide and asymmetrical corridor of overnight interest rate unrelated to discount rate

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