What is Liquidity?
When one talks of liquidity, one is usually referring to the ease at which assets can be converted to cash in order to make payments in a timely manner. Therefore, for both individuals and financial institutions, an asset is considered liquid if it can be easily converted to cash and as such these liquid assets are kept to meet financial obligations.
In Fiji, when the central bank talks about the level of liquidity that is available in the banking system, the RBF is referring to the excess reserves, which are otherwise known as banks’ demand deposits (BDD). This is the ‘liquidity’ we refer to in the rest of this article.
How does the RBF influence Liquidity Conditions?
There are a number of ways that the RBF is able to influence the level of liquidity.
What are the other factors that affect Liquidity?
Liquidity is also affected by currency in circulation (CIC) and foreign exchange reserves. CIC is the total amount of money that is outside the banking system i.e. money in the hands of the public to pay for goods and services, which usually increases during peak spending periods such as Christmas. Foreign reserves represent the income we earn from our exports of goods and services such as sugar, mineral water, garments and tourism, and inflows of aid or loans, which are used for the payment of our imports like mineral fuel, machinery & transport, food, profits & dividends, etc.
While SRD and CIC are inversely related to liquidity, foreign reserves have a direct and positive impact on the level of BDD. This means that an increase in the level of SRD and CIC will lead to a decrease in BDD, while an expansion in foreign reserves would result in a rise in liquidity and vice versa.
Movements in Government’s central account, an operational account held with the RBF also have an impact on BDD. Inflows into the central account include funds raised from issues of Government securities and direct deposits, while outflows include Government’s payments on redemption or interest payments for its securities. Outflows from the central account generally have a positive impact on BDD.
How does Liquidity affect the Economy?
Since liquidity is outside of the RBF’s SRD or reserve requirements, the level of BDD is essentially what banks can use to make loans to the public or for their own investments. A reduction in liquidity would not only affect banks’ willingness to make loans but also the price or interest rate it would charge on a loan. If businesses and private individuals are unable to access loans or the interest rate is relatively higher, then they would defer expansion and/or investment plans and purchases such as a car or house and consumables. This would affect a number of factors including consumer and business demand and confidence, spending in the economy and eventually overall economic activity. In other words, the level of liquidity in the banking system has a bearing on the level of consumption and investment activities in the economy, which feeds into Fiji’s total output or income in a year or the country’s gross domestic product or national income, and ultimately affects economic growth.
Fiji has registered ample liquidity levels over the recent few years, dominated by increased inflows of foreign reserves. The highest level of liquidity of $772.9 million was recorded in November 2013. Currently, at an aggregate level, banking system liquidity remains adequate given that foreign reserves, a key determinant of BDD, is expected to remain sufficient in 2017 and into the medium term.