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SBP plans to change ‘Target Rate’

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KARACHI: The State Bank of Pakistan has decided to review its interest rate corridor framework in order to further strengthen the transmission of monetary policy; and have the desired effect on term structure of interest rate, reported by the Domestic Markets and Monetary Management Department of SBP.

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The main feature of this planned improvement is to introduce a “SBP Target Rate” for the money market overnight repo rate. This rate will be in addition to SBP Reserve Repo Rate (ceiling rate) and SBP Repo Rate (floor rate) of the corridor. Moreover, this rate will be specified within the corridor – lower than ceiling rate and higher than floor rate.

In this context, SBP planned two steps: A proposal to this end will be submitted to the Advisory Committee on Monetary Policy (ACMP) in its March 2015 meeting, for review and its recommendations to the SBP board; and SBP Board of Directors (BoD) will make a final decision about needed improvements in interest rate corridor in its March 2015 meeting.

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Existing interest rate corridor that was established by SBP in August 2009 with SBP reserve rep rate, the policy rate, as ceiling and SBP repo rate as floor, to minimize volatility in the money market did not meet the desired results due to uncertain flows in the system such as government related deposits, borrowing for commodity operations, borrowings from the SBP, etc. While the SBP reserve repo rate (policy rate) served to keep a lid on the upside movement of overnight rate, there was no instrument available with SBP for providing a binding floor to limit its downward movement. As a result, repo rate used to drop very frequently and with high magnitudes.

Such volatility diluted SBP’s efforts to keep the weighted average money market overnight repo rate close to the policy rate that was essential to ensure effective transmission of monetary policy stance of SBP.

*Target Rate: The interest rate charged by one depository institution on an overnight sale of balances at the Federal Reserve to another depository institution, as determined by the Advisory Committee on Monetary Policy (ACMP) of the Federal Reserve.

*Repo Rate/Repurchase Rate: Repo rate is the discount rate at which SBP repurchases government securities from the commercial banks, depending on the level of money supply it decides to maintain the country’s monetary system.

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