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The impact of monetary policy on consumer price index (CPI): 1985-2010

par Sylvie NIBEZA
Kigali Independent University (ULK) - Master Degree 2014

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2.2.3 Monetary policy management

The National Bank of Rwanda implements the monetary policy through three tools:

· Open market operations

· The discount rate

· The reserve requirement

During last decade, the Central bank used a weekly auction for absorbing or injecting liquidity. From May 2008 to date, NBR replaced weekly auction and deposit facility (overnight) by repos operations.

· Open market operations

The Central bank accepts surplus liquidity from banks and in return transfers eligible securities to them as collateral. The two parties agree to reverse the transaction at a future point in time, when the Central bank as borrower repays the principal of the loan plus interest and the creditor bank returns the collateral to the Central bank.

The duration of these operations can vary between 1 to 14 days. Repos with shorter maturities are executed from time to time depending on the forecasts of banking sector liquidity.

Owing to the systemic liquidity surplus in the Rwanda banking sector, repo tenders are currently used exclusively for absorbing liquidity.

The bids are ranked using the Duch auction procedure.

Those with the lowest interest rate are satisfied as having priority and those with successively higher rates are accepted until the total predicted liquidity surplus for the day is exhausted.

If the volume ordered by the banks exceeds the predicted surplus, the Central bank either completely refuses the bids at the highest rate or reduces them pro rata.

Repo tenders are usually announced on Friday after the Monetary Policy Committee`s meeting and on another working day banks can bid for 1-day repo at around 2:00 PM. Banks may submit their orders for example the amounts of money and the interest rates at which they want to enter into transactions with the Central bank- within a prescribed time.

The minimum acceptable volume is RWF 50 million. Bids exceeding the minimum must be expressed as multiples of RWF 50 million.

· Reserve requirement

Cash reserve requirement can affect bank's free reserve in short run and supply of broad money. The cash reserve is one of the instruments available to NBR for controlling base money.

In an attempt to exert control over the money supply progress, the NBR introduced reserve requirements in August 1990. By compelling commercial banks to keep unused a certain fraction of customers' deposits, the central bank sought to sterilize a part of banks' resources usually used in extending credit. Indeed, keeping the required reserves on deposits at the NBR restricted credit expansion and consequently monetary growth rates. This was not part of any structural adjustment program, but may have been in anticipation of such changes.

· Discount window facility

Central banks usually limit access to their funds by commercial banks, by using a penalty rate and /or through the prescribed amount.

Motivated by a concern to supervise more closely monetary growth, the central bank made any credit extension by a commercial bank to its customers exceeding a certain amount subject to central bank authorization. Further, this authorization could not be interpreted as a right to increase the NBR's allocation at the discount window. This element of control made it possible to keep money supply growth within the constraints imposed by economic growth and keeping in mind that certain sectors of the economy were to be offered some priority status. In addition, credit control was likely to involve the central bank in the evaluation of the risk incurred by the banks concerned, and thus lead them to change their behavior and take into account the riskiness of their customers before making a loan. However, having said this, some activities, especially in agriculture did receive special support.

· Foreign exchange operations

The supplementary monetary instrument is foreign exchange operations (sales) mainly to smooth unexpected liquidity fluctuations in the market.

Treasury bills and Treasury Bonds market dominate the money market in Rwanda. Treasury bills can be mobilized for government financing or for monetary purposes for absorbing excess liquidity for long duration. (National Bank of Rwanda, Implementation of monetary policy 2010.)

In 2010, the BNR monetary policy will be conducted in a good international and national environment compared to last year. According to the IMF estimates, the world economic activity would recover by 3.1% in 2010 against a decrease of 1.1% on average in 2009 and come back to the normal trend as the global real GDP has increased by 3% and 5.2% in 2008 and 2007 respectively. This recovery in the world economic activities will have a positive impact on Rwandan external sector as well as the private transfers to Rwanda.

As mentioned earlier, the banking liquidity conditions and the capacity of banks to give loans to private sector have recovered to normal levels since mid-2009 and lending activity has been increasing since the third quarter of 2009. In addition, Rwanda expects an important budget support estimated at USD 5 19.03 million in 2010 against USD 409.63 million in 2009, which is an increase of 26.7%.

Based on these developments and expectations, the credit to private sector is expected to increase by at least 20%, coming back to the high growth rates observed before 2009. Indeed, annual growth of the credit to private sector between 2005 and 2008 was 29% on average and fluctuated between 26.1% and 36.3%. With this estimated level of credit to private sector, real GDP growth could be expected in the range of 7 - 8%, as observed in average during the period 2004-2008. (NBR. Monetary policy and financial stability statement, Feb 2010 p.29)

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