Unpacking the new South African Reserve Bank Monetary Policy Implementation Framework (MPIF)

Fundamentally, the SARB is going to change the mechanism it is currently using to transmit its monetary policy from a market shortage of roughly R30bn to a market surplus of approximately R50bn with a “Tiered Floor” system.

SARB will create a surplus of liquidity in the market through adjusting how it manages its balance sheet.

How will SARB create this liquidity in the market?

Instead of commercial banks borrowing from the SARB at the repurchase rate (repo) in a shortage system, banks will earn interest on surplus cash placed with the SARB at the repo rate.

Banks will be given a quota of liquidity they can place with the SARB. If this is exceeded, the interest rate paid will be repo-100 basis points, disincentivizing the practice of placing excess funds with the SARB, but rather deploying the funds in the commercial banking system.

This is a fundamental shift, in policy implementation, from keeping the market in a cash shortage position, to a controlled surplus, where each bank is provided an allocation of surplus allowance based on the size of their balance sheets, rather than their appetite for funds.

Why change the existing shortage system?

According to the SARB, the implementation of monetary policy via a shortage-based system has become increasingly ineffective, given the build-up of liquidity in the system.

This is primarily because of a build-up of liquidity in response to the Covid-19 pandemic.

While the change to a surplus based system will not have an impact on the repo rate or inflation target, a reduction in bank short term finance rates is expected, as liquidity in the system should be more freely available.

What impact has this system had on the FX swap market?

One impact of the build -up of USD liquidity in the banking system has been a dislocation in pricing between money markets and the USD/ZAR basis swap market (FX swap market). Therefore, the implied Rand funding cost using USD has become more expensive.

There are a few key reasons for the dislocation in the FX swap market.

1. Excess liquidity and cost of ZAR

Firstly, the international banking system, including South Africa has had to deal with excess USD liquidity that flooded the markets as central banks loosened monetary policy and adopted extreme measures, such as bond repurchase programmes. 

In essence, although banks have had vast amounts of liquidity, they have not been able to effectively deploy this liquidity. International banks then swapped this excess USD liquidity for ZAR, buying ZAR assets, but placing demand on the USD/ZAR basis swap market.

Secondly, while the increase in USD/ZAR basis cost foreign investors more to borrow ZAR, the demand for South African financial assets, including government bonds, remained strong.

When one compares the opportunity of earning 0% on a USD deposit, or 3% on a 10-year USD treasury, a yield of 10% on a South African 10-year government bond is very attractive and it is easy to see how such large volumes went through the market therefore increasing the implied cost of borrowing.

2. Challenges with outgoing policy

In order to maintain shortage levels, the SARB sterilizes, the surplus ZAR liquidity injected into the market, using the USD/ZAR swap market. This has contributed to pricing pressure in the basis swap market.  The SARB would sell dollars into the market and buy ZAR at the near date, with the reverse transaction at the forward date, leaving the market saturated with USD, adding to the price pressure.

So, why does the FX swap market impact local interest rates?

The FX basis became more and more expensive due to supply and demand dynamics, and hence the implied ZAR interest rates were pushed higher.

In 2019, the implied yield on the 1-year USD/ZAR basis swap was approximately 3m-Jibar flat – this increased to a peak of 3m Jibar+122bp in 2021 and is currently trading at 3m Jibar+54bp. This is one of the factors that caused short end funding rates to increase, as institutions had to compete with the implied yield of the FX basis market for ZAR funding.

As the SARB phases in the new MPIF, Standard Bank expects to see a further easing of the implied yield in the FX basis market as the forward position is reduced and hence a slight reduction in overall short-term funding costs. Foreign participation in the SA bond market may increase as it becomes cheaper for foreign investors to fund their rand positions.