The transition by the Bank of Botswana (BoB) to a new monetary policy arrangement was not unexpected, given that the central bank has been introducing reforms, the averaging of reserve requirements to ensure that banks can flexibly manage liquidity shortfalls being one of them.
Under Governor Moses Pelaelo, BoB introduced a wide suite of instruments that can be used to satisfy prudential requirements in the banking system, government bonds and likely going forward, corporate bonds included in the scheme. The central bank made it possible to use government securities as collateral and made government debt acceptable in various prudential requirements. Market players expect BoB to introduce more innovations, allowing corporates’ debt to be used for various types of collateral within the banking system to ensure greater dynamism.
After the 28 April Monetary Policy Committee (MPC) meeting, the central bank will adopt a new anchor policy rate – called the Monetary Policy Rate or MoPRA for short – replacing the Bank Rate. The Bank Rate is the rate at which BoB has been lending to commercial banks. After the MPC meeting, commercial banks will borrow from BoB at their discretion using the Standing Credit Facility, which will be maintained at 100 basis points above the MoPRA. Under the previous dispensation, banks mark up on the Bank Rate to have what is called the Prime Lending Rate (PLR). The PLR is the rate at which banks borrow to their customers, which is equal to the Bank Rate plus 1.5 percent. The problem was that commercial banks in Botswana have not had much of an appetite to borrow from BoB at the Bank Rate because of excess liquidity in the financial system. In addition, without the logical foundation, the PLR was not based on anything substantial and is therefore artificial. Analysts argue that in addition to PLR being an artificial construct, the Bank Rate never really fulfilled its original objectives. The only conclusion is that a long time ago, the founding fathers reached an agreement that seemed reasonable at the time, although one without much economic or financial intuitive explanation.
It is perhaps for these reasons that BoB has seen it fit to reform the tools of monetary policy. Economists say what is been done is ultimately a bold experiment, given the information flow at their disposal. More precisely, the transition of monetary policy ought to be, and indeed must be, linked to the prevailing situation of excess liquidity in Botswana’s financial system. Analysts say the central bank is actually doing what it should have done a long time ago. It is now connecting the level and scope of liquidity in the market with interest rates, which in turn should facilitate a more sensible and clearer course of monetary policy. Make no mistake, they argue, introduction of the MoPRA and removal of the Bank Rate is not equivalent to a change in BoB’s monetary policy stance. Rather, it signifies a change in mechanism used to reflect and indeed satisfy the monetary policy stance.
The MoPRA is simply the yield on the 7-day Bank of Botswana Certificate (BoBC). Unlike what the Bank Rate did, it aims to influence liabilities of banks rather than assets. By focusing on the yield of the 7-day BoBC, the central bank is aligning the transmission of monetary policy with actual liquidity absorption, which helps ground monetary policy and provides a significantly clearer framework for steering short-term rates. In other rewards, going forward, money market rates will have a clearer link to liquidity conditions on the ground. That in itself, economists say, is a good thing. This change was based on years of extensive and thorough research and advice from the likes of the IMF. It is also based on comparative evaluation with peers in the region and further afield. While the MoPRA is based on the BoBC yield, the banks are now in a position to set their own PLR after a period of a year. It is only in April 2023 that banks will set their own PLR. In the interim, to allow for stability and contract renegotiation, banks are not allowed to change.
In a competitive market system, analysts say banks should be able to charge rates that reflect their cost of funding and indeed their overall balance sheet, particularly their asset-liability matching (ALM) considerations. But the word around is that there is a lot of anxiety around banks setting their own PLR. Consumers may be scared that without central banks setting it, banks may rip them off. While this is possible, analysts point to two safeguards – the central bank has responsibility to ensure that this does not happen; secondly, consumers are now free to shop around for the best possible deals. It is a win-win situation, hence bankers say consumers need not be fearful of banks setting their own PLR. Analysts also expect banks to look at their own balance sheets and their ALM considerations and come up with a price that makes sense from both a risk management perspective and a return maximisation perspective. Banks have to balance this out for themselves.
According to analysts, the gap between what commercial banks charge should not be materially different, given that there is an ongoing liquidity cycle. This means banks cannot price too far out of the liquidity cycle which is forever changing. Pricing is expected to improve somewhat, though not much materially. As analysts point out, it enhances the market mechanism. It also increases choices for consumers and the central bank will have to more proactively supervise banks to ensure that the interests of consumers are not taken for granted. The key thing is that this is a bold experiment for Pelaelo and colleagues at BoB and there will not be an overnight change even in 2023, although the consensus is that banks are ready and sophisticated enough to meet this challenge.
Even so, observers recognise that BoB will have to be vigilant going forward. This is because there might come a time when the market moves from being in a situation of excess liquidity to a situation of deficit. In such a case, the central bank may then have to quickly devise a new framework on which to base its MoPRA. Right now, the market has excess liquidity, but in the future when diamond revenues and government spending slows, the economy can quickly move into a situation of deficit liquidity. In such a case, instead of absorbing liquidity, BoB will have to inject liquidity into the system for the monetary policy rate to be re-orientated, and thus the MoPRA.
Already the level and magnitude of excess liquidity has been declining over the past decade as terms of trade and balance of payment have deteriorated. While there is talk about excess liquidity, it is actually less prevalent than a decade ago. That is why BoB acknowledges the need to have a dynamic and flexible structure to manage interest rates, given that in the prevailing trend Botswana could find itself in a deficit liquidity environment in the next few years. Even though the banking system is generally characterised by excess liquidity, some banks do experience idiosyncratic liquidity challenges, given their funding models. It is much like the reality of poverty in a rich country, Botswana being case in point!
Economists say Botswana can draw lessons from countries like South Africa and Denmark where protocols for managing excess liquidity present important perspectives for Botswana. South Africa and Denmark set their own PLR within a context set by the monetary authority. Both have different forms of excess liquidity and manage it differently. But the point is that in both markets, the central banks have created a framework where banks can set competitive interest rates for themselves.
But even as banks set their own PLRs, experts caution that they have to be mindful of the constantly changing liquidity cycle that puts them under pressure to charge appropriately. It also means that banks being compelled to further strengthen and develop a transactional banking franchise to ensure that they have ready sources of liquidity. Make no mistake, observers note, within this framework, BoB will absorb and inject liquidity as and when necessary to ensure that the liquidity needs of the market are satisfied. But no one knows how this will pan out in practice. It is an experiment and any innovation has upside and downside risks. The point to emphasise is that this innovation was necessary to ensure that Botswana has a policy that makes sense and is better able to complement fiscal policy to help the central bank achieve its core objective of price stability.
Basically, this means policy makers now have better tools and a more appropriate framework to ensure growth and macroeconomic stability. In other words, GDP growth and inflation will evolve within a context whereby the central bank has more relevant tools to guide and/or support macroeconomic outcomes. The consensus is that a sensible monetary policy working in tandem with a fiscal policy can help achieve macroeconomic stability. As economists explain, macroeconomic stability is key to facilitating growth, which is what finance minister Peggy Serame wants after the pandemic battered the economy. All eyes are on Governor Pelaelo to deliver the goods and take Botswana forward.