Bank of Slovenia’s Operational Bank of Slovenia’s Operational Monetary PolicyMonetary Policy

From the pre-ERM II phase to ERM II and the gradual From the pre-ERM II phase to ERM II and the gradual approach harmonising the operational monetary policy approach harmonising the operational monetary policy

framework to the Eurosystemframework to the Eurosystem

Peter KukanjaPeter Kukanja

2

Slovenia – Facts and FiguresSlovenia – Facts and Figures

• Independent since 1991, EU member since 2004• Currencies: Slovenian tolar - SIT (1991 – 2006), € (2007 – )

• Population: 2.0 million• GDP 29.7 billion €, per capita 14,811€ (2006)• GDP real annual change: 5.2% (2006)• Unemployment rate (ILO): 5.0% (Feb 2007)• Annual inflation rate: 2.3% (Feb 2007)• BoP current account: –2.6% GDP (2006)

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Slovenia – Financial EnvironmentSlovenia – Financial Environment

• Credit institutions (end 2006):– 21 banks– 3 saving banks– 2 subsidiaries

• Banks’ balance sheet total: 120% of GDP (end 2006)• Financial markets:

– treasury bills– treasury bonds

• Eurobonds• domestically issued bonds – listed on the Ljubljana Stock Exchange

– bank and corporate bonds– equities

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Before Accession to the EUBefore Accession to the EU

• Independent monetary policy• Free selection of exchange rate regime• Countries have to:

– ensure the independence of the central bank– ensure the prohibition of financing the state– ensure the liberalisation of international capital flows

• Slovenia:– Sep 1999: new foreign exchange legislation– Jun 2000: a schedule of the liberalisation of international capital

flows was accepted– Jul 2002: a new Bank of Slovenia Act

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Slovenia as EU Candidate CountrySlovenia as EU Candidate Country

• Preparation for the adoption of the euro (obligatory after joining the EU)

• Main task: to bring the rates of price growth in line with the level of Maastricht criterion before the accession to the EU and formation of a long-term and sustainable exchange rate of tolar against the euro macroeconomic balances and stability

• Main challenge: how to control inflation at a fixed exchange rate regime and liberalised international capital flows

• Monetary policy is one of the key factors in decreasing the price growth

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Fulfilment of Maastricht criteriaFulfilment of Maastricht criteria

as of September 2001

November 2001: adopted the Medium-term Monetary Policy Framework – with goal to enter the EMU as soon as possible (Banka Slovenije)

November 2003: adopted the Programme for ERM II Entry and Adoption of the Euro (Banka Slovenije and Slovenian government)

Convergence criterion

Slovenia

Inflation (in %) 3.3 8.2

Long-term interest rates (in %) 6.92 13.96

Deficit (in % of GDP) -3.0 -2.3

Public debt (in % of GDP) 60.0 25.1

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InflationInflation

HCPI - Inflation (y-o-y, %)

0

2

4

6

8

10

12

jan.96 jan.98 jan.00 jan.02 jan.04 jan.06

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Interest Rate Transmission ChannelInterest Rate Transmission Channel

    Normal conditions: with changing the interest rates of the monetary policy instruments it is possible to control the growth of monetary aggregate M3

Slovenia: possible to control M1, but not M3Reasons:– use of indexation of the lending and deposit interest rates slow

adjustments in cost of refinancing commercial banks at the central bank– surplus structural position in the money market banks can manage

liquidity independently (with changes in the assets side of the balance, not in the liabilities side)

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Exchange Rate Transmission ChannelExchange Rate Transmission Channel

General: Changing the intervention foreign exchange rates, foreign exchange buying/selling

Slovenia: Banka Slovenije controlled the dynamics of the foreign exchange market rate growth• controlled imported prices influenced on the growth of the CPI• influence also on borrowings of companies and banks abroad

indirect influence on total credit supply for financing domestic demand• defined the relative price ratios of domestic and foreign goods and

services impact on external economic balance

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Tolar vs € Exchange RateTolar vs € Exchange Rate

Spot exchange rates

170

180

190

200

210

220

230

240

250

jan.99 jan.00 jan.01 jan.02 jan.03 jan.04 jan.05 jan.06

To

lars

pe

r 1

EU

R

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Operational Monetary Policy (pre EU)Operational Monetary Policy (pre EU)

Two pillars strategy (since Nov 2001):

Monetary aggregates Real economic activity indicators

liquidity of the banking system balance of payments

short-term interest rate trend foreign interest rates and interest rate difference

structure of monetary aggregates foreign exchange rate

credit activity of commercial banks wages in the economic and public sector

price rises under the control of government

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Restrictions in Conducting Monetary PolicyRestrictions in Conducting Monetary Policy

• Liberalisation of credit operations requires systemic regulation and supervision of foreign exchange and liquidity risk management

• Underdeveloped foreign exchange and tolar money market ineffective transfer of information from BS to real sector

• Structural position in the money market prevents fast development of money market operations

• Minimum reserves system high cost of financial intermediation of commercial banks

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Structural Position and Liquidity GapStructural Position and Liquidity Gap

-4500

-4000

-3500

-3000

-2500

-2000

-1500

-1000

-500

0

500

jan.95 nov.95 sep.96 jul.97 maj.98 mar.9 jan.00 nov.00 sep.01 jul.02 maj.03 mar.0 jan.05 nov.05 sep.06

Structural position

Liquidity gap / net instruments

Tolar bills

Loans and repo

million € SIT

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Implementation ToolsImplementation Tools

Two groups of tools for implementation of the monetary and exchange rate policy

1. Group of instruments• foreign exchange rate dynamics maintaining external balance• interest rates on a temporary sale or purchase of the foreign

exchange to or from Banka Slovenije influence on the volume of base money

• standing facilities, open market operations, minimum reserves

2. Group of measures• capital adequacy directive avoided exposure of banks to foreign

exchange risks• tolar and foreign exchange liquidity ladder avoided liquidity risk

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Monetary Policy InstrumentsMonetary Policy Instruments

Instrument Type Maturity Frequency Liquidity

Repurchase agreement

Open market operation

one week daily providing

Lombard loan

Standing facility

overnight unlimited access

providing

Tolar denominated bills

Open market operation

60 / 270 days unlimited access / weekly

absorbing

Overnight deposit

Standing facility

overnight unlimited access

absorbing

Accepted collateral: Banka Slovenije’s bills & long-term deposit, Republic of Slovenia treasury bills

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Minimum ReservesMinimum Reserves

Gradual alignment to the ECB regulations:• lowering the rates of reserves to the ECB levels

– sights deposits (from 12% in 2001)– fixed term deposits (from 6%, 2% and 1% – depending on maturity, in

2001)

• adjustment of the basis for the computation– according to the maturity– equalising the treatment of the tolar and foreign exchange obligations

• the increase of the interest rate– from 1% to a market level

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Interest Rates ConvergenceInterest Rates Convergence

2

3

4

5

6

7

8

9

10

11

12

1.jan.02 1.jan.03 1.jan.04 1.jan.05 1.jan.06 1.jan.07

%60-day bill

O/N deposit

SIONIA

Lombard rate

7-day repo

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Operational Basis of Exchange Rate ActionsOperational Basis of Exchange Rate Actions

Large capital inflows and the resulting excess liquidity active exchange rate policy operations

Three main elements:• agreement between Banka Slovenije and banks (“Bank Club”)• temporary purchases of foreign currency by Banka Slovenije –

7-day foreign currency swap (temporary monetisation of foreign currency inflows)

• sterilisation operations through the issuance of the tolar denominated central bank bills (60 and 270 day maturity)

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After Accession to the EUAfter Accession to the EU

General: countries have to accede to the ERM II mechanismERM II: rate of national currency is set against the euro (central

parity rate) – allowed fluctuation 15% (standard fluctuation band), exchange rate intervention

Conditions for accession to the EMU: fulfilled nominal convergence criteria based on Maastricht criteria:– price stability– long-term interest rates– general government deficit / public debt– participation in the ERM II mechanism for at least two years

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Slovenia in the ERM IISlovenia in the ERM II

• period: 28 Jun 2004 – 31 Dec 2006• monetary policy in line with the maintenance of the stability of

the nominal tolar exchange rate• central parity rate: 1 € = 239.640 SIT

– lower point: 203.694 SIT– upper point: 275.586 SIT

• calculated average deviation rate: 0.05%• no major excess of supply or demand of foreign exchange

central rate was at a level sustainable in a long-term• small deviations no need for intervention

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Transition to the Eurosystem (1)Transition to the Eurosystem (1)

Structural adjustments to ease the transition:• replacement of 270-day tolar bills with long-term deposit as a

sterilisation instrument– maturities in 2007– floating interest rate: 0.2% above 60-day tolar bill

• final abolition of the minimum foreign currency liquidity requirement and replacement of swaps with outright purchases of foreign exchange (final abolition of € and $ denominated bills)

• final adjustment of the reserve requirement instruments to the arrangements in the euro area– excess liquidity had to be placed in a long-term deposit

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Transition to the Eurosystem (2)Transition to the Eurosystem (2)

Structural adjustments to ease the transition (continued):• issuance of short-term deposit for the purpose of providing

collateral for euro cash• issuance of 120-day tolar bills with maturities up to the end of

April 2007 for the purpose of better planning liquidity by the banks

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Slovenia in the EurosystemSlovenia in the Eurosystem

• Accession to the EMU: 1 Jan 2007• Introduction of the € and abolition of the Slovenian tolar• Irrevocably fixed exchange rate: 1 € = 239.640 SIT• Common monetary policy in whole euro area• Final national goal: to fulfil the real convergence

– GDP per capita– price levels– structural reforms