Reserve Bank of Australia’s Response to COVID-19 helps SME’s
Managing Risk in a Crisis – Pandemic and Global Shutdown.
June 29, 2020
Caring for Jewellery
July 22, 2020
Australia’s financial resilience to the biggest economic shockwave we have seen since the Great Depression proved to be expedient and bold. We absorbed the initial blow of the insidious Coronavirus through the Federal Governments response in passing the Coronavirus Economic Response Package Omnibus Bill 2020.
The Federal & State Governments, in efforts to slow the spread of the virus, isolated and closed many businesses, however Australia has buoyed this financial onslaught successfully through a combination of mechanisms. These have included newly instituted measures, manual adjustments to market functions, and existing economic structural efficiencies such as a floating exchange rate for the Australian dollar.
Quantitative Easing (QE)
The Reserve Bank of Australia (RBA) supported our economy during this time through use of unconventional policy, often referred to as money printing or quantitative easing (QE).
- This is the first time in Australia’s history that such a strategy has been used. The RBA printed money to inject liquidity through the financial system. This meant in practice that the RBA immediately bought approximately A$50 billion of government bonds issued by the Australian Government and State and Territories treasuries, thereby flooding the system with cash.
- This strategy included the simultaneous introduction of a target of 25 basis points for the yield on three-year Australian government bonds, and a preparedness to buy government bonds in whatever quantities needed to achieve that target.
- This policy response was designed to keep funding costs low across the economy and ensure credit availability to businesses and households from financial institutions.
The following comparisons put the RBA’s A$50bn of bond purchases in perspective. The Bank of England accumulated £375bn (A$750bn) over three years, when it started its quantitative easing scheme during the time of the global financial crisis, stopping in late 2012. The US Federal Reserve reached US$4.5tn (A$6.75tn) in its first five years over this same period!
QE which was used in the US, UK, Europe and Japan to combat the impact of the global financial crisis, is widely regarded as having saved the world economy from collapse. The RBA was fortunate to avoid using an experimental policy as it was considered to be at the time. Australia’s economy could instead be stimulated by cutting interest rates that were much higher relative to other economies. This allowed the RBA to observe QE on the sidelines, rather than participate the first time around.
Conventional Stimulus
More conventional measures undertaken by the RBA to combat COVID-19 include:
- Reducing the ‘cash (interest) rate’ to 25 basis points with forward guidance that the ‘cash rate’ will not be increased until the RBA are making sustainable progress towards their goals for full employment and inflation.
- Introducing a Term Funding Facility under which authorised deposit-taking institutions (ADIs) have access to funding from the RBA for three years at 25 basis points. To the start of June 2020 some A$6 billion had been drawn on this facility. Additional funding will be made available if ADIs increase lending to business, especially small and medium-sized businesses.
- Using daily open market operations to make sure that there is plenty of liquidity in the financial system and using their bond purchases to promote the smooth functioning of the market for government securities.
- Modifying the interest rate corridor system so that balances held in Exchange Settlement Accounts at the RBA earn ten basis points, rather than zero.
Next the RBA turned its attention to alleviating corporate lending blockages, having successfully relieved some very severe dislocation in the government bond market.
Short Term Money Market
The RBA declared a commitment to lend money against corporate bonds in short-term money markets.
- Traditionally the RBA only accepted bonds issued by sovereigns, regulated banks, and AAA-rated asset-backed securities as collateral when extending short term funding to capital markets.
- In practice corporate bond holders can access cash lent from the central bank without having to sell their bonds into the market.
- This policy was designed to breathe life into Australian corporate bond markets, that at the time had been closed to primary issuers since February, with secondary markets having struggled through the lock down period.
- It was considered that the credit risk the RBA would assume would be very small due to these actions. An entity would have to fail for an ultimate loss to occur, whilst the bond posted as collateral would also need to fall into default, or at least be marked down.
- This move targeted the non-financial corporate bond market, which is about $50 billion in size and which has its largest weighting to the property sector.
A lesson learned by the RBA from the financial crisis of 2007-8.
It is undoubted that irreparable damage has been inflicted on many businesses across the economy.
Encouraging a functional bond market has provided the liquidity needed for Australia’s companies in the short term. They have avoided any costly dilution of issuing equity capital.
These measures have also allowed many companies to put their faith in long-term corporate solvency and together with the Federal Government’s “Job Keeper package” has preserved jobs.
It will take much effort from many to see Australia’s way through the ongoing crisis and recovery will very much depend on the medium-term decisions when some of these policies roll off in the coming months.
It is widely acknowledged that the immediate action taken from the outset has lessened the economic damage of the Coronavirus to the community. The Federal Government and its agencies set the framework for success. Let’s see what is in store for Australia in the next instalment.
