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Wednesday, June 12, 2024

A new move for open market operations

By Pham Tam Long

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The State Bank of Vietnam (SBV) has recently made a new move regarding open market operations (OMO). Valuable papers are purchased at a competitive interest rate, instead of a fixed rate as before. The government bond yield has changed starkly following the move, but the interbank market has shown signs of stabilization after strong volatility in the previous week.

At a session of buying back valuable papers via OMO on July 26, 2022, the SBV managed to buy VND15 trillion worth of valuable papers via the one-week competitive bid contract with the winning rate of 3.8% per annum, with eight out of 20 OMO members winning the tender. This was the first OMO session where the SBV offered to buy valuable papers at a competitive bid rate. The winning rate was driven by market forces, with the purchase volume determined by the SBV in line with its monetary management goals.

Impacts on the interbank market

The interbank market is correlated to OMO, and via OMO, the SBV can influence the interbank market via interbank interest rates and liquidity, thus regulating interest rates, money supply, forex rate and government bond yield.

The above move by the central bank shows that it has adopted a more flexible monetary policy stance, especially via OMO, the most popular and flexible vehicle to regulate liquidity in the banking sector and interest rates in line with monetary policy in different periods.

Previously, the offered rate for valuable papers via OMO was always fixed, and when adjust key interest rates, the SBV also offered a rate for purchasing valuable papers accordingly. That is to say the offered rate for valuable papers via OMO was determined by the SBV, not driven by the market, and any adjustment would convey a message of either monetary loosening or tightening.

At the session on July 26, the SBV purchased VND15 trillion at an annual rate of 3.8%, or 1.3 percentage points higher than that in previous sessions (at 2.5%). The rate difference does not carry any special impact, but it marks a change in the SBV’s management of OMO, and sends a message on the interest rate hike, especially after interbank rates rose strongly in the previous week.

The G-bond market is always sensitive to the central bank rates, and seems to have reacted instantly in the wake of the SBV move. At a session the day after, on July 27, the G-bond yield for five- ten- and 15-year terms picked up strongly, at 3.4%, 3.86% and 4.03%, increasing by 37, 38 and 30 basis points against the previous day, respectively.

The G-bond market has reacted negatively after the central bank move when expectations of higher interest rates strengthened alongside higher interbank rates, spurring the G-bond yield.

However, the change by the SBV also has positive impacts. The interbank rate has tended to rise strongly in the past week, with the overnight rate on July 27 averaging out at 4.15%, or 1.25 percentage points over the July 25 session. The dwindling liquidity due to the SBV draining money from the market via promissory note issues and sales of U.S. dollars had spurred interbank rates. The interbank rate exceeding the then offered rate of 2.5% for valuable papers prompted the borrowing demand via OMO at a rate of 2.5% and an on-lending rate at 4-5%. Such movements not only failed to ease the liquidity crunch on the market, but also stimulated dealing in interest rate differential.

As the SBV purchases valuable papers via competitive bid rates, the winning rate will be more aligned with the market rate. Such a change will restrict the dealing in the differential between the OMO rate and the interbank rate, and the amount of money injected by the SBV will help supplement liquidity in the banking system.

It is readily seen that the new mode of purchasing valuable papers by the SBV is similar to the change of the coupon for promissory notes – both of which are key OMO vehicles for the regulator. In 2019, the SBV issued promissory notes with a fixed coupon, but now, the central bank issues such notes at a floating rate. That is to say OMO are gradually becoming more controlled in terms of the volume of money supplied at floating rates in accordance with the regulator’s goals.

Flexible monetary management

Monetary policy has indeed become more flexible of late, but the shift to purchasing valuable papers via OMO is a major leap and it will take time for the market to adapt, especially for assets sensitive to the key rates set by the central bank, such as G-bonds. The rise of the interbank rate last week was mainly due to the SBV withdrawing cash via OMO and the forex market. In other words, the regulator wants to keep the dong interest rate higher than the U.S. federal funds rate which has been hiked continually since early this year by the Fed.

The SBV has proactively hiked the dong interest rate on the interbank market when issuing promissory notes beginning June 21 to drain money from the market with the incremental volumes and with a longer term of 56 days. It is readily seen that the interbank rate has been proactively raised to be aligned to the Fed rate hike of 0.75 of a percentage point on July 28. The corresponding rate hike will ease the pressure on the forex rate that has become overheated this year.

2022 is a year of challenges for the monetary regulator in striking a balance between the forex and interest rates, and between fiscal and monetary policies. The SBV has not given any formal signal on an interest rate hike, but it has made a move on money supply. It cannot be ruled out that the SBV would raise interest rates this year as the Fed has not shown signs it will end its interest rate hike in near term.

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