Monetary Policy in Kuwait - Essay Example

--------------------------- --------------------------- --------------------------- --------------------------- Monetary policy in Kuwait Introduction Monetary policy, in its narrow concept, is defined as the measures focused on regulating money supply. Monetary policy is defined as "the set of procedures and measures taken by monetary authorities to manage money supply, interest and exchange rates and to influence credit conditions to achieve certain economic objectives". It is basically a type of stabilization policy adopted by countries to achieve goals like price stability and high employment rates, enhancing economic growth rates and controlling imbalances in external payments, including the protection of the external purchasing power of the currency through maintaining relatively stable levels of exchange rates. The instruments include means that are available to monetary authorities and that are used to achieve the ultimate aims. Central banks generally use a number of key instruments such as changes in the ratio of legal reserves, the discount rate or the central bank rate, and open market operations. Very often, these instruments are enhanced by using other supplementary instruments, known as direct instruments, generally in the form of instructions issued by the central bank. Direct instruments are much used by developing countries because the nature of the economic problems of these countries and their economic conditions do not allow their monetary authorities to be quite free in applying traditional instruments of monetary policy. Monetary Policy in Kuwait There are three main aspects which determine the framework of monetary policy in Kuwait. Monetary policy represents one aspect of the state's general economic policy. It relates to existing legal and institutional procedures, particularly as the interest rate on the Kuwaiti dinar is governed by legal limits, in addition to issues related to the degree of competition inside the banking system. It also relates to the basic features of the Kuwaiti economy, not only as an economy based on the philosophy of free markets and free capital movement, but also as an oil economy of high exposure, depending on imports to meet a major portion of consumption and investment demand. Framework of Monetary Policy in Kuwait Talking about the monetary policy goals as shown above should not mitigate the important role central banks may play in other economic areas, especially in the area of developing money and capital markets in countries where these markets are lacking. The development of such markets will enable central banks to use one of the important instruments of monetary policy, i.e. open market operations. The Central Bank of Kuwait and the organization of banking business specified the goals of the Central Bank of Kuwait, similar to those of central banks in general. The goals related to the function of the monetary policy of the Central Bank of Kuwait can be stated as follows: To endeavour to secure the stability of the Kuwaiti currency and its free convertibility into foreign currencies. To endeavour to direct credit policy in such a manner as to assist economic progress and the growth of the national in-come. To supervise the banking system in the State of Kuwait. Since the mid-eighties the Central Bank of Kuwait has been on a course dictated by the nature of new developments witnessed by the Kuwaiti economy as a result of a number of internal and external effects of the securities market crisis on the whole economic condition, including the emergence of the difficult debt problem as a key issue threatening the financial system in the country. The Central Bank of Kuwait had no alternative but to make the protection of the banking and financial system its top priority and to take necessary measures to identify repercussions of the securities market crisis and prevent the accumulation of its negative effects on both the Kuwait economy and community. Based on the priority of this commitment, the Central Bank adopted a number of measures, mainly the intensification of banking supervision. In December 1985, the Central Bank of Kuwait provided banks with instructions regarding rules and principles for classifying credit facilities and calculating their provisions and profits. These instructions aimed at identifying the actual volume of the debt problem on technical and objective bases. Under the authority of the ministerial resolution issued on January 15, 1987, regulating the Central Bank's supervision of investment companies, the Central Bank was able to obligate many of these companies to consolidate their financial positions on the basis of criteria applied in light of conclusions and recommendations for taking necessary corrective measures following inspection and assessment of the financial positions of these companies. In November 1976, the Central Bank of Kuwait was authorized to determine interest rates by a legislative amendment to Article (166) of the Kuwaiti Law of Commerce of 1961. In February 1977, the Central Bank of Kuwait set a structure of interest rates with a maximum ceiling of 10% per annum for contractual interest rates on loans of more than one-year maturity, 8.5% per annum on loans not exceeding one year if they were unsecured or unproductive, and 7% per annum on productive and secured loans granted for maturities of up to one year. Interest rates on foreign currencies were left to the contracting parties, who would determine these rates in accordance with interest rates applicable to those currencies in foreign financial markets. This structure remained in effect until March 1987, when the Central Bank of Kuwait set a new structure involving reductions in the maximum limits of interest rates, mainly the reduction in the ceiling on productive lending extended up to one year to 6% per annum and in the ceiling on unproductive loans granted up to one year to 7.5% per annum. Interest rates on loans exceeding one year were to be determined within a margin not exceeding 1% above the current inter-bank rate. This new structure contained new directions for monetary policy on the level of interest rates, notably putting an end to the inactivity of the previous structure of interest rates which had been applied for more than 10 years, in addition to excluding the security element as an effective factor in rendering loans at special interest rates. This was a direction dictated by the lending experience of the credit system during recent years and a direction to urge banks not to concentrate on the security element as a major factor when taking their decisions on financing several economic activities. The framework of monetary policy in Kuwait took a new trend in harmony with the behavior of the macro-economy due to a major change witnessed by the economy after the severe decline in oil revenues, leading to deficits in the general budget, which obliged the State to choose the method of deficit financing by resorting to public borrowing as an experience witnessed by the Kuwaiti economy for the first time since November 1987 through the issuance of treasury bills and bonds. The Central Bank of Kuwait has a number of instruments to use regulating liquidity levels inside the banking system to secure monetary stability, including operations of discounting and re-discounting of banks' commercial papers, swap operations, direct intervention in the money market through deposits, and direct lending operations with banks. With these instruments, the Central Bank of Kuwait can either inject dinars into the banking system or absorb them to influence KD liquidity levels, and thereby influence the levels of current interbank in interest rates. For example, from November 1987 through January 24, 1990, the Central Bank of Ku-wait offered 90 issues of treasury bills and bonds totaling KD 10 billion. On January 20, 1990, the outstanding balance of these issues reached KD 2235 million, which is still less than the maximum limit of public borrowing, totaling KD 3 billion. The subscription ratio of these issues was very high, exceeding 400% for some issues. The volume of Central Bank operations in the open market had reached KD 1839 million during the period from January to December 1989, i.e. a monthly average of KD 153 million. Through these operations, the Central Bank was able to realize marked stability in the money market. In addition, the Central Bank used a repurchase agreement system as a means to cover those daily liquidity requirements faced by banks as a result of unexpected exposure in their accounts with the Central Bank. The KD exchange rate has gone through several developments since it was pegged, in March 1975, to a basket of major currencies of the countries having trading and financial relationships with Kuwait. This CBK exchange rate policy was based on securing relative stability in the KD exchange rate, and thereby stability in domestic prices, especially because Kuwait depends greatly on foreign imports. The exchange rate policy enhances the effectiveness of the prevailing interest rates on KD by lessening the transfer of KD to foreign currencies. The Central Bank of Kuwait has applied many rules and regulations to protect the liquidity and solvency of the banking system. Among these are the liquidity requirements and the setting of maximum limits on loans granted to one customer. The Bank has also applied rules for rationalizing bank lending policies, and has continued to perform its inspection function on the banking system. Furthermore, the Central Bank of Kuwait has stressed the importance of protecting the banking system during the past three years, 1986-1988, when it set a number of rules and regulations regarding the evaluation of different types of bank assets and the building up of necessary provisions. Also, the money-exchange companies have been subjected to Central Bank supervision, and the Bank has widened the scope of its supervision over investment companies. The framework of monetary policy in Kuwait, as shown above, represents a summary of the monetary policy experience in Kuwait. Though the duration of this experience is very short compared with other countries, I believe that it has been a rich experience with its positive and negative aspects. We in the Central Bank o f Kuwait are looking forward to giving monetary policy a greater role, in harmony with many new economic developments. Data analysis Fig 1 Fig 1 shows how the central bank has had the process of liquidity growth in line with the growth of GDP. It is clearly visible that GDP growth has more slope, especially after 2004.whereas M2 has a steady slope. Fig 2 Fig 2 shows comparison of exchange rate and inflation rate. It clearly shows till 2004 inflation rate is almost constant but after that it has changed with high slope. Fig 3 Fig 3 shows comparison of KD and US$ interest rates. We can see except for short duration from Jan to Sept 05 KD interest rate was sufficiently high than US$. Conclusion Although many financial crisis central bank of Kuwait has been able to come up with a effective solution with help of its different effective policies. And has proven it self a leader which can be seen from graphs above. Read More