Elena Ilkova
The Reserve Bank’s reforms to its monetary policy implementation framework (MPIF) will reach a new milestone on April 6 when the daily liquidity surplus in the monetary system climbs to its long-term target of R100bn. It will mark the conclusion of the second phase of the MPIF reform, during which the liquidity target has been lifted from R50bn at the end of the first phase.
The 2022 reform of the MPIF fundamentally changed the way the Bank manages the transmission of its monetary policy decisions into the economy. It does this by managing the flow of liquidity in the money market. The reform caused it to switch from the traditional system, which relied on creating a money market shortage, to a modern system that relies on a permanent liquidity surplus.
This aimed to give the Bank a flexible framework that would insulate monetary policy transmission from interventions to maintain financial stability during crises such as the market disruptions early in the Covid-19 pandemic. A similar policy framework allowed the US Federal Reserve to hike interest rates in March, while simultaneously injecting liquidity to alleviate concerns about banking system stability after the recent niche bank failures.
The Bank’s reform also aimed to eliminate market distortions that had built up after the start of the pandemic, in the expectation that key short-term market interest rates would move closer to the policy rate set by the Bank. Abundant liquidity and ample bank reserves imply a marketwide decrease in liquidity premiums, especially in the short end of the fixed-income market. This will reflect in money market rates, but it will take time and be felt more strongly once the interest rate hiking cycle turns.
When the Bank initially proposed that the MPIF system move from the “classic” shortage to a surplus, it said it would target a liquidity surplus of about R50bn during the phasing-in period, but expected that further expansion would be necessary.
Sterilisation deposit
Implementation of the MPIF began in June 2022 with a 12-week transition, during which the market switched from a R33bn shortage to a surplus of about R50bn. The Bank was able to inject about R80bn of liquidity into the system using two of the tools at its disposal: it reduced its foreign exchange (FX) swaps forward position, releasing R32.9bn; and moved R43.2bn of funds belonging to the Corporation for Public Deposits off the bank’s balance sheet and into the banking system.
Managing market liquidity also has a third component: adjustments to the National Treasury sterilisation deposit account. As long as SA was using a liquidity shortage-based MPIF system it was necessary to sterilise incoming foreign exchange flows to prevent these causing inflationary pressure. This was executed mainly through foreign exchange swaps, but it was enabled by cash the government provided through deposits at the Bank that sterilised liquidity created from the build-up of foreign exchange reserves.
During the 2021/22 fiscal year the Treasury used R26.1bn of the R67bn sterilisation deposits to fund Covid-19-related spending. The remaining R41bn was used during 2022/23 to finance part of the borrowing requirement. As the balance was drawn down during February/March, the funds injected liquidity into the market via the banking system. Though a larger liquidity surplus was always part of the plan, the drawdown of the sterilisation deposits may have accelerated the implementation timeline.
To accommodate the increased market liquidity surplus, the Bank announced a plan to lift the daily liquidity target, which triggered an expansion of bank quotas — the excess reserves banks can deposit at the Bank at the policy rate. It also doubled the system’s liquidity buffer, designed to allow absorption of daily volatility, to R20bn, enabling banks to absorb shocks without resorting to Bank assistance.
