The central bank surprised nearly everyone on Thursday when it announced that it would lift the reserve ratios for passbook deposits and time deposits for financial institutions, effective from July 1, in addition to traditional hikes in its policy rates to help fight inflation.
Using an upward adjustment of reserve deposit ratios to control excess liquidity in the market is a rare move for monetary policymakers. It is a much more emphatic monetary tightening measure, but the central bank more frequently chooses to change interest rates.
Another decision was made on Thursday during the central bank’s quarterly board meeting to lower its aggregate M2 money supply growth target from between 3 percent and 7 percent earlier this year to between 2 percent and 6 percent.
The bank’s latest adjustments could have serious implications for the capital markets and the economy.
The rise in reserve deposit ratios could mean that even the central bank might be starting to question the effectiveness of its consecutive policy rate hikes over the past four years, as the bank’s recent rate increases have generally had no effect on market rates.
One reason that market rates were raised less aggressively than central bank policy rates is because domestic financial institutions have seen inactive funds pile up in the last few years. Consequently, financial institutions are less attracted to the central bank’s short-term negotiable certificate deposits (NCDs) in the face of weak demand for business expansion and investment.
As a result, the central bank has found it increasingly expensive to use NCDs to absorb excess market liquidity while subjecting itself to heavy interest pressure.
With the required reserve ratio hike, the central bank reports it will absorb as much as NT$200 billion (US$6.6 billion) in liquidity from the market. This tightening is to increase fund costs by financial institutions and curb future credit expansion to stem inflation. The bank also hopes to force financial institutions to develop long-term management options for their idle funds rather than rely on NCDs and other short-term tools.
Also, with negative real interest rates persisting — signaling inflation and the erosion of purchasing power — central bank Governor Perng Fai-nan (彭淮南) said the bank would do whatever it could to ease inflation and continue a “slightly tight” monetary stance until year’s end.
Perng’s remark indicated that the central bank has made maintaining price stability its top priority instead of economic growth, hinting at more rate hikes to come. This is likely to pose increasing downside risks to domestic stock and property markets and add more pressure to the economy — which began to show signs of a slowdown last month, according to a government report released on Friday.
The problem is that the tightened monetary policy implemented so far will not contain inflation. As the current level of inflation is largely due to the rise in food and energy costs, the government needs to create policies that help the central bank deal with this typical cost-push inflation environment.
Yet the Cabinet’s imprudence in commencing a fiscal expansion plan on public infrastructure projects will only produce opposing forces that will offset the central bank’s efforts to fight inflation.
With this in mind, it is not difficult to understand why consumer confidence fell to another six-and-a-half-year low this month. To revive consumer confidence, the government must better coordinate policymaking.
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