Benchmark interest rates may be on hold
On the face of it, it appears the Central Bank is not raising interest rates. The overnight lending rate and the weekly repo auction rate have remain unchanged since January and November, respectively. This shows a trend in compliance with politicians’ opposition to raising rates and even their support for lowering them. If you look at the benchmark interest rate, sure, there hasn’t been an increase. But is just one rate really the benchmark rate?
We have another interest rate, what we call the “auxiliary rate” - the late liquidity window. This facility is meant for those unable to balance their books for the day, who turn to the late liquidity window as their last option. Like someone looking for an all-night pharmacy, it’s a resource for bankers stuck in a difficult situation. But if you close pharmacies during regular working hours, the patient will inevitably have to look for a drugstore in the middle of the night. This is the situation bankers are now in.
That the Central Bank has raised the auxiliary rate to 12.25 percent is not that significant on its own. What is important is the level of average funding costs. Otherwise, the auxiliary rate can be 20 or 30 percent, as long as the other rates are lower.
Rates effectively up more than 4 points
At its April meeting, the Central Bank’s Monetary Policy Commit- tee lifted the overnight rate it uses for the late-liquidity window to 12.25 percent. At the time, I wrote that this would bring average funding costs to about 12 percent. As it turns out, funding costs quickly reached that level and now stand at 11.96 percent. This compares with 7.77 percent on Oct. 20, and increase of 4.19 points in just seven months.
The Central Bank has been criticized for funding banks not in the usual manner but with the late-liquidity window. So, what are the reasons behind the Central Bank’s preference for this method? No one thinks that because the Central Bank is not touching the obvious rates that it is not raising rates. It is impossible to think that those politicians who say that interest rates should be reduced do not actually see that interest rates are higher.
Does the Central Bank take pleasure from backing banks into a corner and therefore cutting off practically all other options other than the late-liquidity window? This is extremely unlikely. That leaves us with the notion that the Central Bank is using the late-liquidity window because if it needs to suddenly reduce rates, it can do so without making a formal decision. Should inflation and the exchange rate magically and rapidly decline and the Central Bank decides it no longer needs to fund banks at close to 12 percent, it can do so without holding a Monetary Policy Committee meeting.
If the Central Bank so chooses, it can immediately bring down the interest rate to 9 percent. The late-liquidity window would return to its previous function, and interest rates would quickly decline. It must be that the Central Bank is keeping this in mind when it began using the late-liquidity window like a normal funding instrument. It is not so it can say, “Look, I’m not raising rates.” This would not be believable for anyone.