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Monetary and exchange rate policy
in Peru
Adrián Armas (BCR)
“XXI Meeting of the Latin American Network of Central Banks and Finance Ministries“
May, 2005
2
Motivation
Which are the optimal monetary and exchange rate regimes in a dollarised economy?
How can dollarisation risks, in terms of both the central bank’s reaction function and regulatory issues, be dealt with?
How can confidence in the domestic currency be restored?
The Peruvian experience: inflation targeting in a partially dollarised economy (IT + dollarisation risks control)
3
Agenda
Financial dollarisation and its effects on monetary policy design
Financial dollarisation and its effects on monetary policy implementation
The BCR’s strategy for controlling financial dollarisation risks
4
Financial dollarisation and MP design
Monetary policy framework in Peru
Inflation targeting +Financial dollarisation
risks control
Financial dollarisation considerations
5
Financial dollarisation and MP design
a. The inflation target
Inflation targets in some IT countries
Country Inflation target Target's horizon
Australia 2% to 3% (since 1993) Medium termBrazil 5,1% (for 2005) 1 year
Canada 1% to 3% (since 1998) Medium termChile 2% to 4% (since 2001) Medium term
Colombia 4,5% to 5,5% (for 2005) 1 yearCzech Republic 2% to 4% (since 2005) Medium term
Mexico 2% to 4% (since 2004) Medium termNorway 1,5% to 3,5% (2001) Medium term
Peru 1,5% to 3,5% (since 2002) Medium termPhilippines 4% to 5% (for 2004-2005) 2 years
Poland 1,5% to 3,5% (since 2004) Medium termSweden 1% to 3% (1995) Medium termEngland 2% Medium term
6
Financial dollarisation and MP design
b. The operational target
Interbank interest rate(in percentage points)
Year Average Standard deviation
1998 18,7 6,451999 15,0 4,722000 12,6 2,672001 9,0 0,912002 3,2 0,482003 3,4 0,092004 2,7 0,07
Interbank interest rate volatility has reduced
7
Peru: Interbank interest rate in domestic currency
Apr.04-Apr.05
Interest rates in domestic currency(April 2004 - April 2005)
1%
2%
3%
4%
5%
6%
Overnight in S/.
Interbank
Rediscount in S/.
3,25
1,75
Max
Min
3,5
2,0
3,75
2,25
OctJul AugJun SepApr2004
Nov Apr20
May Jan2005
MarDec Feb
8
Agenda
Financial dollarisation and its effects on monetary policy design
Financial dollarisation and its effects on monetary policy implementation
The BCR’s strategy for controlling financial dollarisation risks
9
Financial dollarisation and MP implementation
Monetary policy framework in Peru
Financial dollarisation considerations:
Phillips curve: relative low pass-through
Inflation targetingAggregate demand:
- foreign currency interest rate
- balance sheet effect
Exchange rate: - UIP- exchange rate inertial term
+
Financial dollarisation risks control
10
Financial dollarisation and MP implementation
The inflation forecasting system
Combines judgement and model-based projections
Main inflation forecasting model: QPM. Semi-structural, calibrated model. Captures main monetary policy transmission mechanisms
Assumes that financial markets are not under stress
11
Agenda
Financial dollarisation and its effects on monetary policy design
Financial dollarisation and its effects on monetary policy implementation
The BCR’s strategy for controlling financial dollarisation risks
12
Peru: Dollarisation Ratio
0
20
40
60
80
79 85 90 95 2000 2005
2000: 70%
2005: 54%
13
Financial dollarisation risks control
Financial dollarisation is decreasing, but still remains high
With high financial dollarisation, the economy is vulnerable to large domestic currency depreciations
The BCR implements policies to mitigate the risks posed by financial dollarisation
IT plus financial dollarisation risks control
14
Financial dollarisation risks control
Monetary policy framework in Peru
Inflation targeting
+- IT- Short term interest rate as operational target- Yield curve in domestic currency
Financial dollarisation risks control
Dedollarisation policies
15
Financial dollarisation risks control
0
5
10
15
20
25
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Inflation target Inflation expectation two years in advance
Source: Consensus forecast
Inflation target and inflation expectations: 1995-2005
Dedollarisation policies: building credibility in the target
16
Financial dollarisation risks control
Dedollarisation policies: long term financial instruments in soles
4,6%
6,6%
5,7%5,5%
3,9%
5,9% 6,0%
4,7%
6,4%
3,6%4,1%
3,1%2,7%
2,5%
8,3%
9,6%9,6%
5,1%
7,3%
6,7%
4,5%
3,9%3,0%
2,0%
6,0%
10,0%
Interbank 6 months 1 year 1,5 years 2 years 3 years 4 years 5 years 6 years 7 years
Yield (%)
April 2003 December 2003 December 2004
Interest rates for domestic currency Treasury bonds
|
17
Financial dollarisation risks control
Monetary policy framework in Peru
Financial dollarisation considerations:
Phillips curve: relative low pass-through
Inflation targetingAggregate demand:
- foreign currency interest rate
- balance sheet effect
Exchange rate: - UIP- exchange rate inertial term
+- IT- Short term interest rate as operational target- Yield curve in domestic currency
Financial dollarisation risks control
- Availability of foreign currency liquid funds:
- High NIR level- Moderation of excessive fx volatility
- High reserve requirements for foreign currency liabilities
Dedollarisation policies
Internalisation of risks and policy responses to negative shocks
18
Financial dollarisation risks control
Net International Reserves
9.28.4 8.2 8.6
9.610.2
12.613.6
0
2
4
6
8
10
12
14
1998 1999 2000 2001 2002 2003 2004 2005 April
(bill
ion
of
US
do
llars
)
Exchange intervention to reduce exchange rate variability has let a process of NIR accumulation.
19
Financial dollarisation risks control
Central Bank Certificates of Deposit (CDBCRP)
0.41.4
1.8 1.6
4.1
8.3
10.0
0
2
4
6
8
10
12
1999 2000 2001 2002 2003 2004 2005 April
(bill
ion
of
sole
s)
NIR accumulation has implied an increase of the CDBCRP’s stock.
20
Peru: Nominal Exchange Rate Jan.99-Apr.05
3.2003.2503.3003.3503.4003.4503.5003.5503.6003.650
21
Financial dollarisation risks control
Interest rate variability
Period Interbank overnight interest rate
Average mean (%)Average standard
deviation (pp)
1999-2001 12,3 2,82002-2004 3,1 0,2
The average standard deviation is an average for monthly standard deviations in each of the two periods considered in the table.
Exchange rate variability
Period Exchange rate
Average mean (S/.)
Average standard deviation (S/. cents)
1999-2001 3,460 1,32002-2004 3,470 1,2
The average standard deviation is an average for monthly standard deviations in each of the two periods considered in the table.
While interest rate variability has been reduced in recent years (2002-2004), exchange rate variability maintains a similar level.
22
Peru: Interbank Interest Rate Jan.02-Apr.05
5.4
0.00
1.00
2.00
3.00
4.00
5.00
6.00
Jan.
200
2Feb
.M
ar.
Apr.M
ay.
Jun. Ju
l.Aug
.Sep
.Oct
.Nov
.
Dec. 2
002
Jan.
200
3Feb
.M
ar.
Apr.M
ay.
Jun. Ju
l.Aug
.Sep
.Oct
.Nov
.
Dec. 2
003
Jan.
200
4Feb
.M
ar.
Apr.M
ay.
Jun. Ju
l.Aug
.Sep
.Oct
.Nov
.
Dec. 2
004
Jan.
200
5Feb
.M
ar.
Abr.
Interbank Standing facilities benchmark Overnight deposits
Interbank, benchmark (ceiling), and overnight deposits (floor) interest rates 1/
(in percentage points)
Escape Clause
23
Concluding remarks
Peru is a financially dollarised ITer
IT + financial dollarisation risks control:Inflation targetInterbank interest rate as operational targetFinancial dollarisation considerations in the QPMDollarisation risks control
Financial dollarisation does not preclude independent monetary policy oriented at maintaining low and stable inflation
24
Concluding remarks
Inflation target fulfilment: 2002 to 2004
Consumer price index(yoy% change)
-1,5
-0,5
0,5
1,5
2,5
3,5
4,5
Jan. 2002
Apr.Jul.
Oct.Jan. 2003
Apr.Jul.
Oct.Jan. 2004
Apr.Jul.
Oct.Jan. 2005
%
Inflationary supply shocks (food and oil)
Gradual financial dedollarisation process