Reserve Bank of Australia Annual Report – 1963 Monetary Policy

Problems of Policy

The economy was in a liquid condition by the end of 1961/62. The private sector's holdings of liquid assets had grown strongly; a high rate of new loan approvals, which had not been accompanied by any significant increase in outstanding advances, had raised the level of commitments against trading banks in undrawn limits; and trading bank liquidity had increased to fairly high levels.

From early in 1962/63 it was clear that there would be further additions to the liquid asset holdings of the private sector during the year. This was implicit in government financial policy and in monetary policy. A substantial further increase in bank liquidity was also in prospect. In formulating and administering monetary policy, the Reserve Bank had to take these matters into account.

The importance of the growth of liquidity in the private sector lies in the scope it gives to the community to change its behaviour quickly should its attitudes and expectations change—to spend more freely and to move into less liquid assets, increasing the capacity of others to spend more freely. Unless attitudes and expectations change, high liquidity poses no immediate threat. If attitudes and expectations change gradually, the consequences need not be a problem. But should they change sharply, they could threaten a return to financially inflationary conditions and pose a major problem for monetary policy.

The likelihood of such a sharp change in attitudes is difficult to assess. The events of recent years have undoubtedly influenced the community towards a more liquid structure of assets, but it is not known how deeply this preference for liquidity is felt, or to what extent it will endure at higher levels of economic activity. The paramount objective of monetary policy in 1962/63 was to provide adequate financial support for a rising level of expenditure so as to increase employment of labour and physical capacity, but policy was influenced by the possible longer-run implications of the growth of liquidity.

These considerations were germane to the Bank's decision to increase the Statutory Reserve Deposit ratio in 1962/63. Since bank liquidity was already fairly high at the beginning of the year, it was considered unwise to allow any further substantial increase over the year as a whole. This decision did not imply any change in credit policy, for the banking system was still left with ample liquidity to finance a relatively high rate of lending. It was, of course, recognised that an increase in the S.R.D. ratio could be misinterpreted as a tightening of lending policy and care was taken to make it clear to banks and to the community that this was not the case. Credit policy had been modified slightly towards the end of 1961/62 to seek a steadying of the rate of new lending commitments, which had been increasing rapidly, and this was soon achieved. But new lending continued at high levels throughout 1962/63. Outstanding advances rose and the current needs of the community for bank finance were substantially met. Even so, total commitments against the banks in undrawn limits rose further. However, the increase in these commitments, which supplement the private sector's liquidity, was by no means as sharp as in 1961/62.

Thus, increasing liquidity influenced the application of banking policy. However, it was in the consideration of interest rate policy that concern about, on the one hand, the rate of recovery and, on the other, the growth of liquidity, was most apparent. As the year progressed it became increasingly evident that trends in the security and capital markets were favourable to lowering interest rates and it was arguable that, although the pace of recovery was reasonably satisfactory, a reduction in rates accepting these market trends would provide a useful but moderate stimulus to expenditure generally, and in particular would make borrowing for capital expenditure more attractive. But it was necessary to recognise that a reduction in interest rates reduces the relative attractions of fixed interest assets and, as its effects spread through the capital market, can tend among other things to encourage the acquisition of equity shares and real assets. It was possible that these factors, in helping to induce a change in community attitudes favourable to a rise in expenditure and financial activity, could perhaps prove strong enough to induce a change so sharp that it would endanger stability.

As against this, although interest rates in Australia were not unduly high compared with some overseas countries, many rates were still at levels little below those which became established following action in 1960/61 to counter a financial boom. Also, price stability meant that the effective cost of borrowing was no longer reduced by price increases, as it had been in earlier inflationary periods.

On these scores some reduction in rates could be considered appropriate to current and prospective economic conditions, while still offering sufficient attractions to holders of fixed interest assets. Moreover, if a flexible interest rate policy were accepted as desirable and if later it became appropriate to raise rates, it could be advantageous to be able to raise them significantly from a lower base to exercise restraint without too great an absolute burden of financial costs.

The case for a reduction in interest rates entailed difficult judgments on many economic and financial matters. These matters were actively discussed between the Bank and the Government over the end of 1962 and the beginning of 1963. The balance of judgment was found to favour a reduction in interest rates. At some future time, a different situation could require an increase in rates. A flexible policy which responded readily in this event could help to obviate the need for wider and more restrictive policy measures.

Trading Banks

Bank lending

Towards the end of 1961/62 the emphasis of monetary policy in relation to bank lending was shifted slightly from providing an active and positive stimulus to the economy to a somewhat more passive policy of moderate expansion, under which, however, banks could still meet commercially acceptable requests for finance. This change was appropriate because economic recovery was under way, public liquidity was high and there was a substantial volume of overdraft limits undrawn. Although public liquidity and the volume of undrawn limits increased further in 1962/63, it was not felt that, viewed in conjunction with the rate of economic recovery, any further change in bank lending policy was necessary. The requests made in 1961, that banks should give special weight in their lending to the need to increase employment and productivity, continue to accord preferential treatment to housing and export production and discourage speculative activities, stood throughout 1962/63.

The rate at which new overdrafts were approved by the major trading banks had risen to fairly high levels during 1961/62. At these levels, continuation of a rising trend would have been inappropriate to credit policy but, with the emphasis of policy on moderate expansion, a fall in overdraft lending over 1962/63 as a whole was not necessarily required. In the event, the rate of new overdraft lending fell in the early stages of the year and then rose during the second half, averaging about the same rate as in 1961/62. In addition, approvals of term loans under the arrangements inaugurated towards the end of 1961/62 averaged almost £1 million a week in 1962/63.

Major Trading Banks Overdraft Lending

The upward trend in advances outstanding, which had emerged towards the end of 1961/62, continued into July but there was little growth in advances in the remainder of the first half of 1962/63. The rising trend re-asserted itself in the second half of the year and over the year as a whole outstanding loans and advances of the major trading banks increased by £70 million, including an increase of £24 million in term loans outstanding.

Although the rate of new approvals of overdrafts steadied and the rate of cancellations and reductions of limits rose, total overdraft limits outstanding increased in 1962/63 by about £90 million. This was a much smaller increase than in 1961/62, when limits outstanding rose by about £160 million. The proportion of aggregate limits actually drawn at the end of 1962/63 was 57 per cent, much the same as at the end of 1961/62. In July, 1961, following a period when banks had been undertaking a relatively low rate of new lending approvals in relation to the demand for credit, the proportion of aggregate limits actually drawn was slightly above 63 per cent.

Bank liquidity

The major trading banks entered 1962/63 with liquidity at a fairly high level. In June, 1962 the ratio to deposits of L.G.S. assets (notes, coin, cash with Reserve Bank but excluding Statutory Reserve Deposit and Term Loan Fund Accounts, Commonwealth Treasury notes and bills and other Commonwealth Government securities) was about 24 per cent and the margin of “free” liquidity above the conventional minimum L.G.S. ratio of 18 per cent was therefore about 6 per cent.

There was no growth in bank liquidity in the first quarter of 1962/63, largely because the Commonwealth Government's loan and Treasury notes issues attracted heavy public support. However, an increase in liquidity over the year as a whole was in prospect, and in the absence of action by the Bank this would have increased the margin of “free” liquidity. The Bank decided that such a development would be undesirable. Accordingly, the Statutory Reserve Deposit ratio was increased by 1 per cent to 11.5 per cent from 31st October, by which time liquidity was beginning to rise. The increase in the S.R.D. ratio did not imply any change in credit policy, which was moderately expansive.

Although trading bank liquidity rose quite strongly in the next few months it became clear that, because of the buoyancy of the Government loan market, the increase in liquidity over 1962/63 as a whole would not be as great as earlier portended and it was not considered necessary to increase the S.R.D. ratio further. The level of liquidity over the year was quite adequate to the needs of credit policy. Aggregate L.G.S. assets increased by £12 million in 1962/63 and at the end of the year the L.G.S. ratio was 24 per cent, leaving a margin of “free” liquidity of 6 per cent, the same as in June, 1962.

Term lending

Last year's Report outlined the special arrangements instituted in April, 1962 to enable banks to undertake fixed term loans, for periods ranging from about three years up to about eight years, for capital expenditure for production in the rural, industrial and, to a lesser extent, commercial fields and also to finance exports. Specific resources to finance these loans were set aside in Term Loan Fund Accounts with the Reserve Bank, representing 3 per cent of each bank's deposits in March, 1962. The amounts were provided as to one-third from existing L.G.S. assets of each bank and two-thirds from each bank's Statutory Reserve Deposit Account, amounting in all to £57 million. The Accounts constituted a revolving fund and it was envisaged that they would permit a steady development of term lending over the next few years.

There proved to be a strong demand for term loans and total approvals had amounted to about £57 million by the end of 1962/63. Drawings against approvals naturally grew more slowly and outstanding term loans were £24 million in June, 1963. The largest proportion of term loans was to manufacturing industries but loan approvals for rural industries were quite high. It is clear that term loans are satisfying longer-term developmental credit needs which would not have been met from overdraft finance and that in some cases they are replacing or supplementing finance from non-bank sources. So far, firm propositions specifically for export finance have been rather few; however loans for rural and industrial purposes could have made an appreciable contribution to export production.

The rate of term lending in 1962/63 exceeded most expectations. It may have reflected some initial demand of a non-recurring nature but, on the other hand, demands generally may strengthen as the facilities become more widely appreciated and as economic recovery dispels remaining hesitancy towards undertaking capital expenditure. As the amounts available in the Term Loan Fund Accounts became more and more fully committed, it was necessary to reconsider their size if a sharp cut in rates of lending were to be avoided. The adequacy of revolving funds such as the Term Loan Funds cannot be judged solely by the balances standing to their credit at a point of time, because for the purpose of determining the amounts available for lending, these balances are supplemented by repayments of previous loans. However, in the early stages repayments are relatively small and at present levels would be insufficient to permit continuation of an adequate rate of lending.

Therefore it was decided, in principle, to augment the Term Loan Fund Accounts to permit term lending to continue at a reasonable rate. In the first quarter of 1963/64, the Accounts will be increased by amounts, totalling £19 million, equivalent to 1 per cent of each bank's deposits, to be provided as to one-third from existing L.G.S. assets and two-thirds from Statutory Reserve Deposits. The transfer from Statutory Reserve Deposits was made shortly after the close of the financial year. It was left to each bank's discretion to decide when to make the transfer from L.G.S. assets, provided it was not deferred beyond the end of September, 1963. The question of further additions to the Term Loan Fund Accounts will be considered from time to time in the light of experience of the operation of the Funds and the conditions then prevailing.

Trading bank interest rates

Bank interest rates were unchanged in the first nine months of 1962/63. In September, the maximum fixed deposit term was extended from twelve months to fifteen months, to provide depositors with a wider choice of maturities at the maximum interest rate, which was not altered.

Early in 1963, the Bank recommended to the Treasurer that at a suitable opportunity bank interest rates should be reduced generally by ½ per cent. It was expected that these reductions would reinforce the downward pressure on rates in the security and capital markets. From the beginning of April, trading bank interest rates generally were reduced by ½ per cent. This move brought fixed deposit interest rates to 3¼ per cent for periods of three months but less than twelve months and to 3½ per cent for periods of twelve to fifteen months. Fixed deposit rates were then ¾ per cent lower for the shorter terms and 1 per cent lower for the maximum term than the levels established in November, 1960.

The maximum interest rate on trading bank overdrafts was reduced from 7 per cent to 6½ per cent in April, 1963; this was the first reduction in the maximum overdraft rate since 1946/47. The trading banks are in general free within the maximum overdraft rate to adjust rates for individual borrowers and classes of borrowers. However, changes in the maximum rate produce, in the light of discussions between the trading banks and the Reserve Bank, a general movement of most lending rates in the same direction and to broadly the same extent. Thus, while the reduction of ½ per cent in the maximum overdraft rate in April, 1963 resulted in reductions through the structure of bank lending rates, not all rates were reduced and some were reduced by less than ½ per cent. In particular, although the preferred treatment accorded to various classes of rural and other borrowers was continued, where increases in rates were not made in November, 1960, for the most part rates were not reduced in April. These variations in carrying through the ½ per cent reduction in the maximum rate accord with the intention of the change in the form of official regulation of overdraft rates, made in April, 1962, which sought to leave banks with as much flexibility as possible in conducting their lending. They did not detract from the achievement of a significant and widespread reduction in bank lending rates, but they are important in principle.

Interest rates on new term loans were reduced along with overdraft rates. For the most part, existing term loans were at interest rates fixed for periods of some years and were not subject to review.

Savings Banks

Savings bank deposits increased by a record amount of £236 million in 1962/63, £78 million more than the previous record in 1961/62; of the increase, £54 million was in deposits of three new private savings banks.

As a result of the rise in deposits, savings banks had more funds available for investment than in the previous year. The total of their new lending approvals for housing, including loans to building societies, was almost double the 1961/62 figure; largely because of lags in drawing approved loans, housing loans outstanding did not rise quite as dramatically as loan approvals, increasing by £58 million, compared with a rise of £34 million last year. Savings banks subscribed heavily to Commonwealth loan issues and their holdings of Commonwealth Government securities rose strongly by £81 million, compared with a rise of £44 million in 1961/62. The increase of £66 million in holdings of local and semi-governmental securities also considerably exceeded the comparable 1961/62 figure. Savings banks continued to consult regularly with the Reserve Bank about their lending and investment policies.

Yields on Commonwealth Government Securities^*

When the reduction of ½ per cent in trading bank interest rates was announced at the end of March, 1963, the Reserve Bank consulted the savings banks concerning reductions in their rates. All savings banks reduced their deposit interest rates by ½ per cent by 1st June. They also reviewed interest rates on their loans and generally reduced these rates by up to ½ per cent, at least reversing increases made in mid-1960/61.

Government Securities Market

Commonwealth Government securities were in demand throughout the year. On ‘change market yields for short-dated securities edged down almost continuously during the first nine months of the year, by a total of about ¼ per cent. Yields on medium-dated securities were slower to move but declined by about 3/16 per cent in the first nine months. Long-dated yields were fairly steady and fell by only about 1/16 per cent late in this period.

The early completion of the Commonwealth's domestic cash loan programme encouraged the continuation of these market trends, and yields, particularly those for long-dated issues, fell sharply following the announcement at the end of March of reductions in bank interest rates. Interest rates on Commonwealth conversion loan and Special Bond issues were subsequently reduced and the issue price of Treasury notes increased in line with the market. Over the year as a whole, reductions in bond yields were of the order of 9/16 per cent on shorts and 7/16 per cent on medium and long-dated securities.

On June average figures, the Bank's holdings of Commonwealth Government securities (other than Treasury notes and Treasury bills) rose slightly by £7 million in 1962/63; in 1961/62, on the same basis, holdings had declined by £68 million. With trading bank liquidity rising much less strongly than in 1961/62 and Treasury notes now continuously available to meet short term investment requirements, the Bank acquired securities on balance as a result of its sales to and purchases from banks and dealers in the short term money market, and these net acquisitions more than offset its substantial net sales to meet the demand for securities fr??? investors.

The market in existing semi-governmental issues was rather more active than in earlier years and the general pattern of market yields on semi-governmental securities declined slightly in the first eight months of 1962/63. Yields fell rapidly in March and there was a further decline following the bank interest rate reductions. These movements brought the general pattern of market yields on semi-governmental issues well below the then existing £5/7/6 per cent public issue rate. At the close of the year the first public issues in respect of the 1963/64 borrowing programmes came on the market, at a rate of £5/-/- per cent for medium and long-dated securities. In these issues a rate of £4/17/6 per cent on the shortest-dated maturity option was also offered. These were the first occasions on which different interest rates for different maturities had been offered by semi-governmental bodies on public issues for some years.

Short Term Money Market

Interest rates paid by dealers in the short term money market fluctuated quite widely at times during the year in response to changes in the volume of funds offering, but showed little trend movement. The minimum call rate was again 2 per cent and rates ranged up to a maximum of 4¾ per cent.

The limits imposed by the Bank on the amounts of funds which dealers may accept were progressively raised by some £25 million during the year to over £140 million. These limits have been designed to assist orderly development of the short term money market and to guard against undue disturbance of the bond and loan markets from a sudden heavy demand for securities by dealers, a risk which has diminished to some extent since the advent of Treasury notes, which provide a suitable short term security for dealers' portfolios.

Except in periods of seasonal tightness in money, the limits placed on dealers have, since the inception of the official market, prevented them from accepting all funds offering and some of the unplaced money has found its way to an unofficial market, operating without any Reserve Bank backing as lender of last resort but, in the circumstances, having a fairly reliable volume of funds available. With Treasury notes providing a suitable avenue of investment for holders of short term funds, the increases in limits in 1962/63 may have brought total limits more nearly in line with the amount currently available to the dealers in the short term money market. From time to time as the year progressed, dealers tended to press less against their limits, but had much more frequent recourse to the Reserve Bank for marginal amounts under lender of last resort arrangements, to cover those occasions when, for various reasons, new funds were not immediately available to replace amounts withdrawn from the market.

Exchange Control

Exchange control policy continued to be consistent with the encouragement of overseas investment in Australia. Remittance overseas of all forms of current income earned by non-residents continued to be freely allowed and repatriation of capital to be authorised wherever this was sought.

The amount of overseas-owned capital entering Australia increased in 1962/63; loans, at reasonable rates of interest, and largely for development purposes, appeared to be more numerous. The number of transactions involving portfolio investment in Australia dealt with by Exchange Control was again at a relatively high level. Non-residents of the Sterling Area have for some time been permitted to purchase Australian securities with “security sterling” held on blocked account in the United Kingdom; this has posed some technical problems in distinguishing, in subsequent dealings, these securities from those paid for in a fully convertible currency.

Exchange control policy permits direct investment overseas by Australian residents, but in a limited range of circumstances. An increasing number of applications are being received from local companies seeking to extend their operations to overseas countries.

Efforts to increase exports have resulted in the entry of Australian exporters into markets where extended terms of payment are generally looked for. Where competition from other suppliers willing to grant extended terms of payment compelled the granting of similar terms for Australia to obtain the business, and providing it was otherwise appropriate to do so, approval was granted for terms beyond the normal maximum of six months after shipment. The number of these cases rose in 1962/63.

Further steps were taken during the year both to simplify exchange control procedures and to ensure that they are appropriate to current needs.