Under a policy of inflation targeting, the stability of interest rates is no less important, than the stability of inflation. The interest rate channel plays a key role in this, through which the central bank affects market rates with its further transmission to consumer, savings, investment behavior of the population, and, ultimately, affecting inflationary processes. Nowadays, the problems in banking system create significant difficulties in the formation of an interest rate channel.
After significant shocks in 2015, the situation in the money market has relatively stabilized in 2016. Starting from February 2016, the structural tenge liquidity continuously grew in the banking system. NBK, which is committed to the policy of inflation targeting, has been withdrawing the excess liquidity of banks at the lower limit of the base rate.
Until a certain time, the interest rates of one-day repo (TONIA) were tightly at the lower limit of the base rate. This behavior of market interest rates suggested that the liquidity surplus was evenly distributed among banks, and they placed it entirely in monetary policy instruments of the regulator, mainly through short-term notes of NBK.
However, since August last year, we note, that TONIA rates are characterized by significant swings (Fig.1). Such deviation of rates from the lower limit of the base rate suggests that individual banks from time to time experience a significant liquidity deficit and they are ready to borrow money in repo market at a rate significantly higher, than the NBK borrowing rate (in some cases, higher than 1pp).
If we examine the market rates for excess liquidity in tenge, an opposite picture is observed on the currency swap market at KASE (Fig. 2). Interest rates in this market until December last year were concentrated at the lower limit of the base rate, too. However, starting from mid-December, the rates of SWAP 1D, SWAP 2D fell sharply.
Recall, in December, KKB received a loan from the NBK as a short-term provision of liquidity. After that, the rates in the swap market fell dramatically and the volume of transactions increased sharply, which indicates a significant increase in demand for FX currency in exchange for tenge liquidity. The demand for currency in swap market was so great, that banks in need of currency, instead of placing free tenge funds in NBK, were ready to use them in swap market at rates well below the base rate. In general, as of now the volume of currency borrowing in swap market has reached a record level and since March it consistently is above the level of $2.2 billion (Fig. 2).
Based on the report of the regulator "Open position on NBK operations", (http://www.nationalbank.kz/?docid=776&switch=russian), until recently NBK took a little part in providing currency in swap market. This allowed banks to earn high interest rates on their foreign currency assets. By providing currency funds to the swap market, banks received funds in tenge at a rate well below the base rate. By placing the same funds in NBK, banks earned a higher interest margin, than deposits in foreign currency.
Since April 11, the rates on KASE swap market have grown considerably and stabilized at the level of 9.5% per annum, which is unprofitable for banks, since at this level the profitability of placements in NBK notes is not so attractive. In addition, from the same date, the NBK's open position on these transactions has increased significantly, which gives us reason to believe that the rates on swap market increased under the influence of the regulator.
We also note, that in the market of currency swap transactions on KASE until late December last year, there was no participation from NBK. Since December 28, the regulator began to provide currency on KASE for tenge liquidity, despite the fact that this tool is not consistent with the inflation targeting policy.
In our opinion, the problems of individual banks distort the market formation of money market rates in the banking system. As a result, the observed volatility and the opposite behavior of interest rates in repo markets and swap operations adversely affect the stability of the money market, which creates significant problems in the implementation of inflation targeting policies. We believe, that carrying out an effective interest policy of the regulator and achieving the target level of inflation will be difficult until the problems of the banking sector are resolved.