Monetary Policy

Introduction to Tasks and Objectives of the Monetary Policy Department

Preface:

The primary objective of the monetary policy department is to achieve domestic price stability and to maintain stability in the exchange rate of national currency against the foreign currencies by formulating and implementing prudent monetary and exchange rate policies. Achieving such objective would not be possible in the absence of a stable national currency. Therefore, the central bank strictly monitors the exchange rate behavior and intervenes in the market under the managed floating exchange rate regime to minimize the impacts of sharp exchange rate volatility on the level of commodity prices as well as other macro-economic indicators.

Objectives and Tasks:

1. Monetary Policy Formulation:

According to the second article of Da Afghanistan Bank’s Law, the primary objective of the central bank is to achieve and maintain the domestic price stability. Achieving such objective is not possible in the absence of stability in the value of national currency.

Since Afghanistan is a small open economy with a long-lasting trade deficit, thus the exchange rate volatility impacts the domestic price stability. Therefore, DAB monitors the exchange rate behavior and maintains the managed floating exchange rate regime to harmonize monetary and exchange rate policies.

To evaluate its monetary policy, Da Afghanistan Bank has set the following targets:

- Setting ceiling on the reserve money growth,

- Setting ceiling on the currency in circulation growth,

- Setting floor on the accumulation of net international reserves (NIR)

Liquidity:

Liquidity plays an important role in the economy and changes in the level of liquidity should be consistent with the economic growth and the needs for money in the economy. Considering the banking sector expansion and its role in creating money, the economic conditions of the country, DAB has set reserve money as the primary and currency in circulation as the secondary index of liquidity. To manage the reserve money growth, DAB utilizes two monetary tools; the foreign exchange auction and the open market operation (sale of capital notes) as the primary monetary policy instruments.

1.1 Monetary Policy Implementation:

Da Afghanistan Bank implements the monetary policy by using the existing monetary policy instruments.

1.2 Monetary Policy Instruments:

Da Afghanistan Bank utilizes foreign exchange auction and open market operation (sale of capital notes) as the primary monetary instruments.

a. Foreign Exchange Auction: Foreign exchange auction is conducted twice a week in accordance to the foreign exchange auction regulation. The selling of foreign exchange is done through an open and transparent auction process in which the licensed foreign exchangers dealers and commercial banks are participating.

b. Capital Notes Auction: The second monetary policy instrument used by Da Afghanistan Bank is the capital notes that are sold to commercial bank on a weekly basis. In order to expand the use of this instrument, which could be an important alternative for foreign exchange auction, Da Afghanistan Bank introduced new capital notes of 364 day in addition to the existing capital notes of 28 day and 182 day, this increases investment opportunity in this instrument. Da Afghanistan Bank intends to develop the secondary market of CNs to increase the role of this instrument in managing the liquidity.  

Meanwhile, Da Afghanistan Bank uses the other monetary policy instruments such as the reserve requirements, not only for the precautionary and supervisory purpose, but also utilize it for monetary policy implementation. Currently, the reserve requirements ratio is 8 percent in Afghanistan. 

2. The Exchange Rate Policy of Da Afghanistan Bank:

Formulation, adoption and implementation of the exchange rate policy is one of the DAB’s monopolized duties which is explicitly described in the article 69th of DAB law. Among the eight types of exchange rate regimes across the globe, Da Afghanistan Bank adopted the managed floating exchange rate regime. Based on this regime, the exchange rate is determined by the market mechanism.

Taking into consideration the economic conditions of the country, balance of payments (imports and exports), and the economic openness of the country (inflow and outflow of foreign exchange), as well as the political conditions of the country, the adoption of such exchange rate regime is more appropriate than other regimes.

2.1 Foreign Exchange Reserves of Da Afghanistan Bank

As mentioned earlier, one of the quantitative targets that DAB uses to evaluate its monetary policy effectiveness is the level of net international reserves. Like the other quantitative targets, the level of net international reserves is determined taking into account the status of the economic indicators, inflows of foreign exchange into the country, and the projected foreign exchange auctions. Accumulation of the net international reserves increases the public confidence and stabilizes the value of domestic currency.  

In the recent years, the significant increase in the level of foreign exchange reserves, which is one of the main indicators of the national economy, is one of the DAB’s major achievements. However, the increase in the level of foreign exchange reserves has a direct impact on the implementation of the monetary policy, as well as  controlling other indicators such as the exchange rate of national currency, inflation, and maintaining a stable balance of payments.

Organizational Structure of the Monetary Policy Department:

The monetary policy department has a Director General with the following four deputies:

- Deputy Director for the Monetary and Fiscal Sectors

- Deputy Director for the Research and Real Sectors

- Deputy Director for the External Sector

- Deputy Director for the Economic Publication and Reporting

The monetary policy department studies and monitors the following four main sectors:

- Monetary Sector

- Real Sector

- External Sector

- Fiscal Sector

Monetary Sector

Monetary Sector is one of the important sectors of the Monetary Policy Department. This sector is responsible to compile raw data from various sources. After the compilation, this sector sorts, and reviews the data and performs necessary calculations. Finally, based on the available data, the analytical reports that can be used in decision making process are produced. The final reports are shared with the relevant national and international organizations.   

The Main Functions of the Monetary Sector:

Data collection:

1- To obtain the exchange rate of afghani against various currencies, one of the MPD employees along with one person from the Market Operation Department visits Sara e Shahzada (the main money market in Kabul) and collects the special exchange rate forms, which includes the rate of afghani against a basket 9 foreign currencies, from 10 exchange dealers on a daily basis. The foreign currency basket includes: the U.S. dollar, Euro, Pound Sterling, Swiss Francs, Indian Rupees, Pakistani Rupees, UAE Dirham, Saudi Riyal, and Iranian Riyal).

2- To calculate and to understand the overall condition of the monetary indicator, and to analyze changes in these indicators, to find out the reasons behind such changes, the monetary section collects data from the General Treasury and the Currency Issuance sections of the Banking Operations Department, as well as data from the Core Banking System (CBS) regularly. In case of any significant changes, possible solution will be presented.

3- To analyze the overall NIR position and to find the reasons behind any changes in the NIR level, this sector uses data from the Core Banking System CBS and the IMF website. Moreover, data on the foreign exchange inflow is provided by the Market Operations Department. It is worth mentioning that total value of the NIR is expressed in U.S. dollar.

Reviewing Data and Monetary indicators:

After collecting data from received from various sources and performing required calculations, the exchange rate trend and behavior, the level of net foreign exchange reserves, and other monetary indicators are monitored regularly. In case of any severe fluctuations in the exchange rate of afghani, the main causes are analyzed and the proper suggestions are provided.

Participation in the Process of Foreign Exchange and Capital Notes Auctions

Da Afghanistan Bank has adopted the managed floating exchange rate regime. To contain fluctuations in the exchange rate of afghani and to maintain domestic price stability, DAB intervenes in the market via foreign exchange auction, twice a week, and the capital notes auctions on weekly basis. Representatives from the monetary sector participate in the foreign exchange auction committee meetings regularly and provide committee with technical advice while determining the amount of foreign exchange to be sold.

Reflecting the Monetary Developments in the Quarterly Publications

The monetary sector reflects the monetary developments in the economic publications of Da Afghanistan Bank, especially in the quarterly and annual bulletins, produced by the Monetary Policy Department. 

Real Sector:

This sector is responsible to compile and analyze statistical data on the macroeconomic indicators. The sector works with a close cooperation with the Central Statistics Organization (CSO) and collects raw data such as the gross domestic product (GDP), consumer price index (CPI), and other indicators from CSO. After the data collection, all the primary data are reviewed to assure its accuracy. Following the review and necessary calculations, the data is provided to the analysts to produce analytical reports. Such analytical reports are produced on monthly, quarterly, and annual basis, and make them accessible to all national and international users through economic publications of Da Afghanistan Bank.

To adopt, formulate and execute prudent and effective monetary policy, making short term and long term projections of some macroeconomic indicator are critical. Therefore, one of the most important tasks of this sector is to forecast some of the macro-economic variables.

External Sector:

This sector is responsible to collect statistical data on the foreign trade (exports and imports of goods and services), primary and secondary incomes as well as the financial and capital transactions of the country with the rest of the world. External sector statistics are the key economic indicators for the central banks and other monetary institutions. Such statistics provide information on the foreign reserves position as well as the liabilities of the country including liquidity and foreign debts. In addition, the external sector statistics provide information on the transfers of remittances, inward remittances from the Afghan workers abroad and vice versa. Specifically, the required statistical data for the balance of payments are the transactions between residents and non-residents in the country.

The external sector statistics are compiled on a quarterly basis. Moreover, this sector prepares analytical reports for the DAB quarterly and annual statistical and economic bulletins. In order to improve the quality of the external sector statistics, the data from various sources such as the international transactions reporting system (ITRS) which is mainly collected  from commercial banks and used by the government and non-government organizations, are being used. A timely data collection is highly critical while formulating the monetary and exchange rate policies. Moreover, the external sector statistics are also of great importance for other macro-economic policy makers as well as the private sector.

Fiscal Sector:

The monetary and exchange rate policies are formulated and implemented in a close coordination with the fiscal policy of the country. Therefore, the central bank has a close cooperation with the Ministry of Finance. The Fiscal Sector of the Monetary Policy Department collects the fiscal data such as the government revenues and expenditure, finance sources of the national budget and so on from the different departments of the Ministry of Finance. After the data is compiled, the data is reviewed and placed in the specific tables by the statisticians and the final data is provided to the sector analysts. Based on the data, the analysts prepare analytical reports for different time periods. After the final revision is done, the reports are published in the economic publications of the central bank.

In addition, attending the Cash Management Committee meetings, held on a monthly basis with participation of Ministry of Finance and DAB, and other relevant meetings are the other responsibilities of this sector. The main purpose of CMC is to exchange views regarding the government expenditure, revenue collection and success or failure of the government in spending the budget over the past month and make required decisions for the elimination of existing shortcomings and complications.

Economic Research Section:

In addition to the above mentioned four sectors, the economic research section has been established under the MPD to conduct economic researches in national, regional and international levels. The main responsibility of this section is to carry out the required economic researches on the overall economic conditions of the country as well as carrying out researches on the economic activities in the regional and global levels. The sector observes and reviews the macro-economic indicators to provide information about the potential impacts of changes in the indicators on the overall economy.

As stated above, conducting economic researches and producing research papers are the main duties of this section. The research reports are provided to the General Director of the monetary policy department in timely manner. It is worth mentioning that the research results assists the policy makers to have a comprehensive picture of the overall economic conditions of the domestic and the global as well as a comprehensive picture of the potential impacts of the changes in the macro-economic indicators on the economy while formulating the monetary policy.

Economic Publication and Reporting

According to Da Afghanistan Bank’s law, the central bank is responsible to produce monetary policy performance reports and plans as well as an overall economic performance reports for different time periods and send it to different government institution such as the Parliament, Office of the President, key ministries, and other relevant on a timely manner.

Article 105 of Da Afghanistan Bank’s law has obligated the Central Bank to produce the semi-annual reports on the performance and execution of the monetary policy in the first six months of the year and the monetary policy plan for the next six months of the year, as well as an overall economic performance report to the Parliament. 

Moreover, producing and publishing of economic and statistical bulletins is one of the important tasks for the central bank. The monetary policy department has the responsibility of producing and publishing such bulletins on a quarterly and annual basis. It is worth mentioning that the bulletins are prepared in English language without any assistance from the foreign advisors. DAB circulates copies of the bulletins to many Central Banks, International Organizations, foreign embassies in the country, the Afghan embassies abroad, and other interested users, regularly.

 Fortunately, such publication are highly welcomed and appreciated by most of the domestic and foreign users and many appreciation letters have been forwarded to DAB in this regard. To meet the domestic users’ demand, the MPD is intended to publish these bulletins in the official languages of the country.

In addition, this section of the MPD produces updated performance reports of the key departments such as the monetary policy, market operations, financial supervision, and the payment twice a month, and presents it to the senior management of DAB including the Supreme Council members to keep them update.