If the motivation for the latest MCP decision was proper, so was the decision not to raise reserve requirements.
I openly stated on Tuesday my expectation about the Central Bank (CB) Monetary Policy Committee (MPC) decision. I expected that the MPC will moderately increase reserve requirements in the case that the recent developments are read as the start of a new episode of growth and will keep the reserve requirements constant otherwise. I didn’t anticipate any cut in the interest rate corridor or the policy rate. The MPC did not change the reserve requirements, but lowered the upper bound of the interest rate corridor by one percentage points.
I am focusing rather on the reserve requirement decision. Not that I think it was the wrong call. I already was expecting either a moderate increase or no change. I concentrate on the decision on reserve requirements in order to derive a lesson about the future of the monetary policy. None of these is new actually; I have raised these several times on different occasions here. Yesterday’s MPC decision just has strengthened the point.
Here is a quote from the MPC press release dated 19 February: “The Committee has indicated that credit growth displays a significant acceleration amid strong capital inflows. In order to contain the risks on financial stability… it was deemed appropriate to implement a measured tightening through reserve requirements.” In this direction, the MPC decided to raise reserve requirements as it also did in the earlier meeting.
The release from 26 March says: “Credit growth has been hovering above the reference rates during the early months of the year amid strong capital inflows. However, there is a deceleration in capital inflows in the recent period.” In this respect, the Committee did not change reserve requirements upon the expectation that credit growth rates will decrease due to the automatic stabilizer mechanism.
Do you know when the decision on 19 February about reserve requirements became effective? On 15th of March! That is, when capital inflows started to slow down and hence the MPC expected an automatic slowdown in credit growth. In other words, if the motivation for the latest MCP decision was proper, so was the decision not to raise reserve requirements. On the other hand, due to the decision taken in the previous MPC meeting, reserve requirements were raised at the very timeframe when the MPC in its latest meeting argued that reserve requirements should not be increased! So, here are some lessons:
One: reserve requirement rate is not a flexible policy tool. The decision becomes effective minimum four weeks after it is taken. The developments taking place meanwhile might put the CB in a difficult position.
Two: It is not possible to lower credit growth by raising reserve requirements unless the Banking Regulation and Supervision Agency steps in. The CB should have learned this lesson already given the experiences between the late 2010 and mid 2011.
Three: financial tensions lower both credit supply and credit demand as it weakens the risk appetite. We witnessed a sharp example of this in the second half of 2011. Given the current circumstances, monetary policy option that involves active intervention in reserve requirements should be avoided unless the underlying cause of the tension is completely eliminated.
This commentary was published in Radikal daily on 28.03.2013
