Questions and answers about the intervention in the exchange market announced by Banco de la República
1. What are foreign reserves and what are their current levels?
Foreign reserves are liquid assets abroad controlled by the monetary authority. For an external asset to be considered as reserves, it must be under the direct and effective control of the monetary authority and must have an availability for immediate use. Maintaining international reserves facilitates the operation of Colombia´s international payments and the access of the Government and the private sector to international capital markets. As of August 31st, 2018, net foreign reserves reached a value of 47,537 million dollars.
2. What is the exchange rate regime in Colombia? What are its advantages?
In Colombia, the exchange rate regime is flexible. In a regime with exchange rate flexibility, the exchange rate operates as an adjustment variable in the face of shocks to the economy, reducing the volatility of interest rates and economic activity. Second, exchange rate flexibility allows the interest rate to be used independently as an instrument to bring inflation and output closer to their desired values. Third, exchange rate flexibility reduces the incentives to take excessive foreign exchange risk by the agents of the economy, which is vital for maintaining financial stability.
3. Is there a level of equilibrium of the nominal or real exchange rate that the Board of Directors wants to achieve?
No. The announced program is not aimed at generating a depreciation of the currency.
4. What is the FCL?
The flexible credit line (FCL) is an instrument created by the International Monetary Fund (IMF) for countries with very strong economic fundamentals and institutional frameworks of sound economic policy, with the purpose of providing support in episodes of external tension. Since it is restricted to countries with strong monetary policy frameworks, it does not imply any conditionality on the part of the IMF and its access is immediate. The FCL was approved by the IMF on May 25th, 2018 for an amount of Special Drawing Rights (SDR) 7,848 million (approximately US $ 11,000 million).
5. What does intervention in the exchange market imply for the monetary policy?
When buying international reserves, liquidity in the local currency is given to the economy in exchange for USD dollars. Sometimes this liquidity may be higher than the one that was going to be demanded from Banco de la República at the intervention interest rate. In these cases, to prevent the market interest rate from falling below the policy interest rate, the Central Bank must collect liquidity. This can be done through various instruments, such as deposits in the Central Bank from the Government or banks, or sale of the Central Bank´s portfolio of public bonds.
6. What are reserve accumulation put options?
They are contracts that give the entities participating in the auction the option to sell dollars to Banco de la República at a later time as long as the exercise condition is met.
7. How does the mechanism work?
In scenarios where the exercise condition is met, viz. when the current exchange rate (TRM) is below its moving average of the last 20 working days, the entities can deliver US dollars to Banco de la República in exchange for pesos, which are settled at the representative exchange rate of the current market. The options are of the American type, which means that entities can exercise their right to sell dollars to the BANREP at any time during the contract´s term and as long as the exercise condition is met. The first day that sales could potentially be made is on the business day after the auction. The option may be exercised totally or partially. In the case of partial use, the balance may be exercised any day of the remainder of the original term of the option in which the exercise condition is active.
8. How does the auction scheme work?
The right to use the put option is acquired with the payment of a premium in legal currency, whose unit will be pesos for every thousand dollars. At the auction, Banco de la República receives the premium offered by the counterparts of the operations and these positions are ordered from highest to lowest. The auction cut rate is determined at the point where the total amounts demanded are equal to the amount offered. The rate of the last offer that would be assigned is applied to all other positions.
9. What entities can come to Banco de la República´s options auctions?
In general terms, the entities that can buy the Banco de la República´s exchange intervention options are the banks, the financial corporations and the financing companies with technical equity equal to or greater than the minimum capital that must be accredited for the constitution of a financial corporation. Specifically, Banco de la República may sell the put options for the accumulation of reserves to the Intermediaries of the Exchange Market (IMC in Spanish) referred to in numeral 1 of article 8 of the Resolución Externa 1/18, that are registered in Banco de la República pursuant to article 7 of the aforementioned resolution, as well as with the Nation-Ministry of Finance and Public Credit. Additionally, these entities must maintain permanent instructions with Banco de la República in accordance with the provisions of numeral 6 of Circular Reglamentaria Externa DODM-143.
10. Can the options be traded in the secondary market?
The options may be negotiated between agents authorized for these operations by sending SWIFT messages to Banco de la República as indicated in the Foreign Exchange Manual.
11. What is the duration of the reserve accumulation program?
There is no predefined duration of the program and the Board of Directors of Banco de la República will evaluate it based on the available information.
12. How many auctions will take place?
There is no predefined number of auctions and Board of Director of Banco de la República will evaluate it based on the available information.
13. How often will the auctions take place?
Monthly.
14. Why is this program going to be done through put options?
Because, as the statement says, the Bank seeks to accumulate reserves by minimizing the impact on the exchange rate.
15. Are there concerns that the mechanism may generates devaluation pressures?
This program is not aimed at generating a depreciation of the currency. For this reason, the mechanism used to acquire the reserves will be the auction of put options to sell US dollars to Banco de la República. This prevents the Bank from making purchases in periods of upward pressure on the exchange rate.
16. Is it going to be sterilized? How and when?
To guarantee the compatibility of the foreign exchange intervention with the target inflation strategy, the purchases and sales of foreign currency are sterilized. However, this is done only to the extent necessary to stabilize the short-term interest rate to the level that the Board of Directors of the Bank considers consistent with the fulfillment of the inflation targets and with the evolution of the output around its potential level.
