THE BOJ has once again hiked short-term interest rates. The 90-day and 120-day repurchase (repo) rate (the rate at which BOJ buys securities from its primary dealers) was increased by an average 2 percentage points at one go. This is the second time in a matter of days that the Central Bank had to jack up interest rates to ease pressure on the foreign exchange market.
As is customary, the increase in rates had the desired effect as it cooled the perceived overheating in the foreign exchange market. As a result of this latest intervention by the monetary authorities the local dollar is now trading at $49.29 (Tuesday October 15) and has gained 34 cents since the hike in rates.
The reliance on interest rates to stabilise the dollar, at a time of heavy seasonal demand, has become a permanent feature of our economic landscape. What this means, however, is that, at least in the short-run (most likely for the end of the year), short-term rates have moved up. As a result the next time the government comes to the market to raise funds it will have to pay investors higher returns to part with their funds. This sill impact directly on the country's interest costs on its internal debt for as long as the rates remain high - worsening an already precarious situation.
A point allied to this is that whenever the Central Bank jacks up short-term interest rates, when the Ministry of Finance returns to the market with medium to long-term issues to fund government's expenditure, it has to pay higher rates to attract investors to part with their funds for longer periods. Put another way, drastic swings in interest rates are a major disincentive to a vibrant medium to long-term money market.
All told then a reversal of declining interest rates to protect the local dollar against its US counterpart translates into higher costs for the economy. More importantly however the frequent hike in short-term rates is a timely reminder of how fragile the economic recovery is.
The message in all this remains that it is only a real increase in foreign exchange earnings, mainly facilitated by expanded export earnings, that will keep the local dollar stable. This is a major challenge any new government must face.
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