Lessons Learned from Countries that Experienced Difficulties in the ...

0 downloads 130 Views 1MB Size Report
Main Themes. • Most countries exit from pegs under stress and is therefore ... Easy to operationalize and manage in th
Lessons Learned from Countries that Experienced Difficulties in the Transition from Fixed to Float David Vavra

Kyiv, May 2017

Main Themes • Most countries exit from pegs under stress and is therefore better to be prepared • Successful transitions require – a deep and liquid foreign exchange market – a coherent intervention policy – an appropriate alternative nominal anchor, e.g. Inflation under Inflation Targeting – adequate systems to review and manage public and private sector exchange rate risk

• The room for effective capital flow regulation gradually evaporates after the float – deepen the financial markets – strengthen financial system supervision and regulation – strengthen macroeconomic policy management 2

OVERVIEW OF MAIN ISSUES

3

Flexibility is gaining ground among developed economies • Advanced Countries: Exchange Rate Regimes, 1991, 1999, 2006 (Fischer, 2008) , and 2012 90%

1991

Percent of total countries

80%

1999

70%

2006

60%

2012

50% 40% 30% 20% 10% 0% Hard-peg

Intermediate

Float

Source: 2012 advance countries list is from World Economic Outlook, April 2013

4

… while EMEs increasingly face only two options: float or peg • Emerging Market Countries: Exchange Rate Regimes, 1991, 1999, 2006, and 2012 60%

50%

1991 1999

40% 2006 2012

30%

20%

10%

0% Hard Peg

Intermediate

Floating

Source: Emerging markets is SPR department official list

5

Yet exits are often disorderly Figure 2. Exits by Exchange Rate Regime, 1990–2002 160 Number of Exits

140

Orderly exits

120

Crisis-driven exits

100 80 60 40 20 0 Total

6

Source: IMF

From hard pegs, From horizontal From managed fixed and and crawling floats crawling pegs bands

… mostly triggered by external forces Figure 3. Exchange Rates Against the US$ 90 100 110 90 130

80 150

70 170

60

190

210

Angola

Kazakhstan

Azerbaijan

230

Sources: Bloomberg, Datastream and IMF staff calculations.

7

Nigeria

Russia

Saudi Arabia

Commodity price index

50

40

… aggravated by domestic macroeconomic imbalances

8

Source: CNB

Fixed exchange rate regimes • Easy to operationalize and manage in the short-term • Long-term costs in terms of – Higher macroeconomic volatility – Higher dollarization and financial sector vulnerability to FX risks – Lower stabilizing power of domestic central bank as the LOLR and MMOLR – Risk of disorderly adjustments and high interest rates

9

Exchange Rate rate flexibility • Difficult to implement and manage • If well managed, then long-term benefits in terms of – Lower interest rates – Lower macroeconomic volatility – Lower dollarization – Flexibility and insurance in terms of the LOLR and MMLR 10

Lesson #1 Pegs often lead to higher long-term exchange rate volatility

11

01-01-15

12 Source: NBG

30-07-15

23-07-15

16-07-15

09-07-15

02-07-15

25-06-15

18-06-15

11-06-15

04-06-15

28-05-15

21-05-15

14-05-15

07-05-15

30-04-15

23-04-15

16-04-15

09-04-15

02-04-15

26-03-15

19-03-15

12-03-15

05-03-15

26-02-15

19-02-15

12-02-15

05-02-15

29-01-15

22-01-15

15-01-15

08-01-15

Stable FX?

1.3

1.25

1.2

1.15

1.1

1.05

1

Stable FX? 2.2000

2.0000

1.8000

1.6000

1.4000

1.2000

1.0000

GEL

13

Source: NBG

KZT

Lesson #2

Pegs do not guarantee nominal stability

14

… and similar is true for output growth or financial sector stability 35 Ukraine Україна

Poland Польща

30 25

Czech. Чехія Rep.

20 15 10 5

0 -5 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Source: Bloomberg

1

Lesson #3

Most peg exits are unprepared (and under stress), and well sequenced reforms are needed for success

16

Key ingredients of a successful move to flexibility A coherent/ consistent interventio n policy

A wellfunctioning FX market

Supportive macroecon omic and structural policy mix

Greater exchange rate flexibility Systems to monitor/ma nage FX risk

17

A credible alternative nominal anchor

Capacity to implement the new MP framework

Key ingredients of a successful move to flexibility A coherent/ consistent interventio n policy

A wellfunctioning FX market

Supportive macroecon omic and structural policy mix

Greater exchange rate flexibility Systems to monitor/ma nage FX risk

18

A credible alternative nominal anchor

Capacity to implement the new MP framework

Lesson #4 Alternative monetary policy regime with inflation as the new nominal anchor

19

Principles of Effective Monetary Policy* • Price stability as the overriding objective • Medium-term inflation objective as the basis for policy actions and communication • Operational independence, mandate and accountability towards the objective • Clear and effective operational framework aligning market conditions with the policy stance • Transparent forward-looking monetary policy strategy that – reflects the monetary transmission mechanism. – bases policy actions on an assessment of implications for the economy and financial stability

• Transparent communication about policy objectives and 20 actions * Evolving Monetary Policy Frameworks in Low-Income and Other Developing Countries; IMF Policy Paper; October 23, 2015

Inflation Targeting Regimes as a particularly successful example • Price stability as the overriding objective • Medium-term inflation objective as the basis for policy actions and communication • Operational independence, mandate and accountability towards the objective • Clear and effective operational framework aligning market interest rates with the policy stance and a flexible ex rate • Transparent forward-looking monetary policy strategy that – reflects the monetary transmission mechanism. – bases policy actions on an assessment of implications for the economy and financial stability

• Transparent communication about policy objectives and 21 actions * Evolving Monetary Policy Frameworks in Low-Income and Other Developing Countries; IMF Policy Paper; October 23, 2015

Operationalizing the inflation objective under IT Headline Inflation, % yoy

 Inflation targeting adoption is officially confirmed in the Monetary Policy Guidelines for 2017 and medium term

50

(approved by the NBU Council)  Inflation targets for 2017-2020 are irrevocable

40

30

Inflation targets 20

12%±3 pp 10

8%±2 pp

5%±1 pp

6%±2 pp

Dec 2016: 12.4%

0 2015

2016 Source: NBU

2017

2018

2019

2020 22

Lesson #5

Inflation as the new nominal anchor

23

Expectations are effectively anchored on the target 8 7 6 5

36-month ahead expectations

Inflation

4 3 2 1 0 -1

24

Source: CNB

Lesson #6

Interest rate based policy

25

Predictable movements of less volatile market interest rates up to 72

35

up to 49

NBU policy and Overnight Interbank rates, % pa

30

25

20

15

10

5

0 2007 26 Source: NBU

2008

2009

Key policy rate

2010

2011

Overnight loans

2012

2013

2014

Minimum term CDs

2015

2016

2017

Overnight interbank

Lesson #7

Flexible exchange rate with an intervention strategy, consistent with the regime and well communicated

27

Importance of FX interventions has increased after the crisis, also for ITers • After the crisis the use of FX interventions has intensified in both developed and emerging markets – 20 out of 30 pure inflation targeting regimes regularly intervene on the forex market (and 16 out of 18 countries EME ITers

• FX interventions as a systematic instrument to support a flexible exchange rate is an accepted paradigm now 28

Tasks  accumulation of international reserves  smoothing out the functioning of the FX market  Supporting the transmission of the key policy rate as the main monetary policy instrument

Principles  FX Strategy is consistent with Inflation targeting and floating ER  NBU insists in minimizing the role of FX intervention as policy tool  NBU does not counteract fundamental trends, only smooths their effects  Criteria of banks’ participation are open and transparent Source: NBU

Forms • • • •

FX auctions single-rate interventions request for quotations targeted interventions

FX interventions Strategy

Communications the NBU maintains a reasonable level of transparency while disclosing information about its intentions to conduct FX interventions and their outcomes 29

Key ingredients of a successful move to flexibility A coherent/ consistent interventio n policy

A wellfunctioning FX market

Supportive macroecon omic and structural policy mix

Greater exchange rate flexibility Systems to monitor/ma nage FX risk

30

A credible alternative nominal anchor

Capacity to implement the new MP framework

Lesson #8 Exchange rate flexibility should come in stages to stimulate the development of the FX market and FX risk management tools

31

2.0

Aug-90

Apr-90

Jan-90

32 Source: Bank of Israel

Aug-01

Apr-01

Jan-01

Sep-00

Jun-00

Feb-00

Oct-99

Jul-99

Mar-99

Nov-98

Aug-98

Apr-98

Dec-97

Aug-97

May-97

Upper band

Jan-97

3.0

Sep-96

Jun-96

Feb-96

Oct-95

Jul-95

Mar-95

Nov-94

Aug-94

Apr-94

Dec-93

Sep-93

May-93

Jan-93

Oct-92

Jun-92

Feb-92

Nov-91

Jul-91

Mar-91

Dec-90

From Fixed Peg to a Float in Israel

6.5 6.5

6.0 6.0

5.5 5.5

5.0 5.0

4.5

Midpoint rate 4.5

4.0 4.0

3.5 3.5

Currency basket 3.0

2.5 Lower band 2.5

2.0

Lesson #9

Balanced net open FX positions and developed risk management instruments before significant flexibility

33

5/7/1996 27-09-1996 20-12-1996 14-03-1997 6/6/1997 29-08-1997 21-11-1997 13-02-1998 8/5/1998 31-07-1998 23-10-1998 15-01-1999 9/4/1999 2/7/1999 24-09-1999 17-12-1999 10/3/2000 2/6/2000 25-08-2000 17-11-2000 9/2/2001 4/5/2001 27-07-2001 19-10-2001 11/1/2002 5/4/2002 28-06-2002 20-09-2002 13-12-2002 7/3/2003 30-05-2003 22-08-2003 14-11-2003 6/2/2004 30-04-2004 23-07-2004 15-10-2004 7/1/2005 1/4/2005 24-06-2005 16-09-2005 9/12/2005 3/3/2006 26-05-2006 18-08-2006 10/11/2006 2/2/2007 27-04-2007 20-07-2007 12/10/2007 4/1/2008 28-03-2008 20-06-2008 12/9/2008 5/12/2008 27-02-2009 22-05-2009

Direct and Indirect FX Risks

0.65

0.55

Deposits

0.45

Loans

0.35

0.25

0.15

Implicit IT 2002 - 2005

34 Source: CBRT

Full-fledged IT

Financial Dollarization in Turkey

0.05

Source: CBRT

Key ingredients of a successful move to flexibility A coherent/ consistent interventio n policy

A wellfunctioning FX market

Supportive macroecon omic and structural policy mix

Greater exchange rate flexibility Systems to monitor/ma nage FX risk

35

A credible alternative nominal anchor

Capacity to implement the new MP framework

Lesson #10 Better exit from a position of strength and well prepared

36

Prudent fiscal, willing to resolve systemic banking issues Public Sector Deficit, UAH bn, and Public Debt, % of GDP

Consolidated Budget Balance, % GDP 4

"+" surplus

240

100

180

75

120

50

60

25

2 0 -2 -4 -6 Cyclical balance Structural balance w/o NBU Primary balance Total balance

-8 -10 2011

2012

2013

2014

2015

2016

2017

Source: MFU; NBU staff estimates

0

2018

2019

0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Bank recapitalization & other (incl. VAT) Naftogaz General government deficit Public debt, % of GDP (RHS)

37

Lesson #11 Reforms must be broad and well-sequenced both inside and outside the central bank

38

Broad reforms inside the bank

39 Source: NBU

Monetary policy

 Shift from over discretionary policy to rule-based policy, from pegged to floating exchange rate.  The decision-making process and monetary policy implementation are based on the inflation targeting practices.  Enhanced independence of central bank and avoidance of fiscal dominance.

Banking system rehabilitation

 Diagnostic study (AQR + stress test) for the top 60 banks (over 98% of the sector assets) accomplished, bank recapitalization progress is significant.  Country’s largest bank nationalized (after failing to fulfil capitalization program) to prevent system-wide contagion and secure financial stability.  Detailed related-party lending diagnostics completed, banks are implementing relatedparty loan unwinding plans.  Ultimate beneficiary owners of all Ukrainian banks identified and legalized.

Banking system supervision

 Risk-based supervision concept being implemented.  Early-warning system put in place to identify bank problems in a timely manner.  New regulation on credit risk assessment approved, new rules enacted since 2017 after a trial period over Sep-Dec 2016.  Anti money-laundering policies have been enhanced, about 10 banks closed for moneylaundering practices.  Basel-compliant capital and liquidity rules currently being developed.

NBU transformation

 Overhaul of the organizational structure: strengthening core functions, downsizing noncore functions, optimizing regional presence.  Roles of internal committees enhanced.

Sequencing of pillars of a new monetary policy regime Effective MP implementation based on interest rate Effective market based intervention strategy Monetary policy based on strong analytical and forecasting capacities Effective communication strategy 40

Well sequenced with market developments

Intervention Policies

Development of FX Market

Building up FX Risk management and regulation

Credible Monetary anchor, capacity building

Stage 1:

Stage 2:

Stage 3:

Stage 4:

Fixed peg

Limited exchange rate flexibility

Considerable exchange rate flexibility

Float

41

adapted from IMF WP/04/126

… and with the liberalization of capital flows liberalization

42

Exchange Rate Flexibility and Capital Account Liberalization • There are risks to opening the capital account before exchange rate flexibility is allowed – Opening capital account may potentially destabilize domestic liquidity conditions, create macro-economic imbalances, precipitate currency attacks – Pegged/intermediate regimes found to be more crises prone for countries open to capital flows

• Allowing exchange rate flexibility before eliminating controls on capital flows helps to: – Absorb better the real effects of capital flows – Avoid short-term speculative capital inflows by reducing perceptions of low FX risks 43

Basket Peg w ith +/- 0.5 % Band

Monetary Policy Operational Capacity

+/- 7.5 % Band

Managed Float

Exchange rate regime

Free Float

140

Repo operations

Interest rate targeting

Early stage of a corridor system Public support and communication

Official IT

FX risk management Limits on open FX and positions in place regulation

Corridor system finalized Forecasting capacity IT capacity improved

130

Limits on short open positions

Intervention strategy a standard instrument

Credit Inflow FDI, Portfolio, Securities Inflow s liberalized had been permitted

Account at CNB for privatization revenues

Capital inflow liberalization

The Czech Republic

Source: “Operational Aspects of Moving To Greater Exchange Rate Flexibility: Lessons from Detailed Country Experiences”, Occasional Paper, no. 256

2001M5

2001M1

2000M9

2000M5

2000M1

1998M9

1998M5

1998M1

1997M9

Most remaining outflow s liberalized

1997M5

1997M1

1996M9

1996M5

1996M1

1995M9

1995M1

1994M9

1994M5

1994M1

1993M9

1993M1

1993M5

44

Intervention volumes published

Other transactions liberalized

FDI and some other outflow s liberalized, especially during last quarter of 1995

Capital outflow liberalization

1995M5

110

100

FX market

1999M9

Intervention policies

Bank-client market liberalized, derivative market rapid boom

1999M5

120

Fee on FX transactions w ith CB

1999M1

Obstacles on forw ards relaxed; surrender requirements relaxed

FX risk incorporated into capital requirements

CONCLUSIONS

45

• Move to flexibility from a position of strength • The regime change should be part of a comprehensive policy strategy change, including supportive fiscal policies and banking sector reforms

• Gradual transition to float through more flexible pegs allows time to prepare for orderly exits in terms of policy reforms and capacity building • Preparation can take time, risking being forced out of the peg by markets • Take advantage of the mutually reinforcing link between flexibility and – building inflation-oriented and interest-rate-based policy framework – risk management and market development

• Gradually removing asymmetries in the openness of the 46 capital account support FX flexibility

Recommendations • Since operational capacity takes time to build, preparation should start early • Some exchange rate flexibility should be allowed at an early stage to reinforce the operational “pillars” • If already open to capital flows, countries should be prepared for a quick pace of exit • Exchange rate flexibility should be embraced prior to fully liberalizing the capital account • It is important not to wait too long and to let the 47 market inflict the exit

David Vavra Managing Partner [email protected] www.ogresearch.com