The South African Reserve Bank (SARB) has announced a number of interventions to help the country’s economy deal with the coronavirus pandemic – including the purchasing government bonds.
The SARB has entered short-term funding markets, providing additional liquidity in exchange for repurchase agreements for maturities of up to 12 months, it explained in a statement published on Thursday (26 March).
“This will assist with the continuous flow of funding to institutions over different time frames. In normal market conditions, such funding is readily available. It has become less abundant in recent days due to high-risk aversion,” it said.
The SARB said it will also commence buying government bonds in what is called the secondary market.
“These purchases should help to reduce excessive volatility in the price of government bonds,” it said.
“The bond purchases will be held by the SARB in the Monetary Policy Portfolio (MPP). The MPP is a liquidity management tool of the SARB, and can be used for both injecting and draining liquidity. These purchases support ‘price discovery’ – when buyers and sellers easily reach an agreed price for their transactions.”
Why has the SARB done this?
Since the outbreak of Covid-19, financial markets, such as the money, bond, equity and foreign exchange markets have seen extraordinary levels of volatility and extreme price movements.
Among its functions, the SARB has the responsibility to ensure that its monetary policy decisions are effective and that these decisions have an impact, even if it is an indirect effect, on the cost of borrowing in the economy.
In addition, the SARB has a responsibility to ensure that financial markets operate smoothly and efficiently.
“Owing to the volatility and the sudden movement of many prices over the past two weeks, the SARB has implemented several measures to provide liquidity into the market, to stabilise markets and to ensure their orderly functioning,” it said.
“Orderly functioning in the market for government bonds is important for financial stability, and indirectly ensures the effectiveness of monetary policy by keeping market prices for assets consistent with the repurchase rate.”
What does the SARB aim to achieve?
Orderly functioning in the market for government bonds is important for the sustained financing of government, for financial stability and for monetary policy.
This ‘price discovery’ – the easy matching of buyers and sellers of bonds – can be upset by sharp spikes in risk aversion in local and overseas financial markets. The SARB’s action seeks to ensure that buyers and sellers conclude transactions more easily.
Is this a form of quantitative easing?
The SARB has stated definitively that this is not quantitative easing.
“The SARB is seeking to reduce dysfunctionality in the market rather than determining prices. This may, however, result in price movements as demand and supply come into alignment. This is, however, not the primary objective,” it said.
Quantitative easing is generally applied where interest rates are zero or close to zero, and inflation is far below the central bank’s target or even threatening to turn negative.
In advanced economies where interest rates are at or close to zero, quantitative easing has been implemented through the purchase of a range of assets to support growth and investment. In general, these countries have used quantitative easing to raise the level of inflation.
The SARB said is not seeking to do this.
“South Africa does not have interest rates at or close to zero and the SARB is therefore not using this tool as a means to stimulate demand. The SARB’s intervention is a financial market tool aimed at injecting liquidity into the market and ensuring a smoothly functioning market, rather than for economic stimulus purposes.”
Is this akin to printing money and will it cause inflation?
When risk aversion increases and economic actors sell assets for cash, this generally takes cash out of the markets. This can have negative effects on the economy and also lead to further declines in asset prices.
The SARB’s action supports demand for those assets by being a buyer for some of those assets and, in the process, injecting cash into the markets. Under these circumstances, the SARB’s actions are not likely to lead to higher inflation.
Decisive action welcomed
The virus impact will have severe negative implications for all economies with depth and duration of the decline still uncertain, said Albert Botha, head of fixed income portfolio management at Ashburton Investments.
Financial markets have been in turmoil since late February leading to financial stress. This has resulted in most central banks taking swift, decisive and bold monetary policy measures.
Botha noted that the SARB announced a 100 basis points cut to the repo rate last week at its March Monetary Policy Committee (MPC) meeting, lowering the repo rate from 6.25% to 5.25%. Following this action money market rates also declined but to a slightly lesser extent.
Prior to the MPC meeting it became increasingly clear that parts of local funding markets including the bond market is facing liquidity stress, which included increased repo rates to facilitate bond market transactions.
Smooth and efficient functioning of the local bond market became increasingly challenged as we saw over >300 basis points of increases across almost the entire yield curve on ever decreasing liquidity characterised by bid/offer spreads in South African Government Bonds (SAGBs) widening out to 20 basis points to 40 basis points as of Tuesday, 24 March, Botha said.
Normal spreads are in the 0.5-2 basis points range.
The next action by the SARB was to increase its weekly repo operations to now conduct daily operations and extended the term of the funding operations for banks to improve liquidity in the system.
The standing facilities lending rate – the rate which SARB provides liquidity to commercial banks – was adjusted to in line with repo, Botha said.
“The SARB further reduced the borrowing rate for banks from repo -100 to repo -200. Subsequent to these actions we have seen the repo market for SAGBs become more liquid and rates were adjusted down.”
“We welcome the actions taken to alleviate liquidity pressures in the banking sector and restore market functioning,” said Botha.
“The opportunity cost of not introducing the above measures would be that the government’s funding could remain at elevated levels for a protracted period, which is far from ideal at a time when gross domestic product growth is falling, and the borrowing requirement is climbing.”