At the mercy of interest rates. . . rather than exchange rates

19 Jul, 2019 - 00:07 0 Views
At the mercy of interest rates. . . rather than exchange rates Minister Ncube

eBusiness Weekly

The currency reforms from Treasury and the Reserve Bank of Zimbabwe two weeks ago have brought a sense of stability to pricing of products and services, but, the possibility of interest rates hike must be closely guarded to make sure consumers do not suffer another round of price increases.

In its currency reforms, described by Finance and Economic Development Minister Mthuli Ncube as the last of his “shock policy reforms”, Government outlawed the use of foreign currency as a means of payment for local transactions.

“The British pound, United States dollar, South African rand, Botswana pula and any other foreign currency whatsoever shall no longer be legal tender alongside the Zimbabwe dollar in any transactions in Zimbabwe,” reads Statutory Instrument 142 of 2019.

Further, in a bid to support a fledgling currency, roiled by black market speculation, the RBZ through exchange control directive RU102 of 2019, hiked its overnight lending rates to 50 percent from 15 percent.

Minister Ncube is on record saying Government will not hesitate to raise interest rates above their current level of 50 percent to deal with speculative borrowers.

This, he said, was meant to curb speculative practices that had seen individuals and companies borrowing from banks to buy foreign currency on the parallel market resulting in the exchange rate spiralling to US$1: RTGS$15 at some point.

That decision, to abandon the multi-currency system, has since proved a master-stroke, as exchange rates have not only come off on the parallel market, but have also stabilised.

Prices of some basic goods have also stabilised and in some instances have since come off. Notable price reductions were noticed in products such as washing powder from $88 to $40, Mazowe from $21 to $14 and some brands of cooking oil to $18 from above $25 at some point.

But with banks starting to adjust lending rates, the benefits might soon be short-lived.

High interest rates are often a key ingredient in chronic inflation countries for stabilisation programmes. Even when the exchange rate is used as a nominal anchor, policymakers frequently resort to a tight interest rate policy in order to slash liquidity and thus ensure a quick fall in inflation.

Last week, some local banks advised their customers that lending rates were soon to be reviewed upwards. Prior to this, interest rates were capped at 12 percent.

Some of the interest rates seen in the market, show that individuals borrowings, mortgages and corporate loans will pay interest rates of more than 30 percent.

This will put a strain on both consumers and corporates who will need to borrow to fund working capital among other things.  As is described in US Monetary Policy: An Introduction (2004), published by the Federal Reserve Bank of San Francisco, “Changes in real interest rates affect the public’s demand for goods and services mainly by altering borrowing costs, the availability of bank loans, the wealth of households and foreign exchange rates.”

Clothing retailer, and Zimbabwe Stock Exchange (ZSE) listed entity, Edgars Limited has already hinted on a possible increase on both its credit sales and interest payments.

“We expect this (interest bill) to go up further in line with the expected increase in the bank lending rates,” managing director Linda Masterson told shareholders in a trading update last week.

The expected rate hike, will hit hard on a company whose finance costs had already gone up by 80 percent in five months to May.

Faced with interest rate hike in bank loans, increased interest rates on credit purchases, and increased prices on the back of increased borrowing costs by corporates, consumers will come out worse off.

“We are in the process of increasing interest rates charged on customer accounts due to inflation and the increased cost of borrowing,” Masterson has already said and she is not the only one.

Themba Ndebele, chief executive of another ZSE listed entity Truworths, said if the company’s bankers were to review interest rates upwards, the retailer will be left with no choice but to follow suit.

“We will have to review (our interests on credit) because it’s an increase in costs to the business,” said Ndebele.

Prices might also have to go up if the company has to borrow to purchase merchandise. He, however, said the extent of the increase will depend on how much interest rates would have gone up.

However, although high interest rates on a long-term basis are considered to have a negative impact on an economy, analysts also expect local banks to utilise their know-your-customer (KYC) information to offer genuine corporate customers low interest rates.

Secretary in the Ministry of Finance and Economic Development George Guvamatanga, said the development will not have an impact on long-term borrowers such as firms.

“What we are reviewing are short-term interest rates. Long-term interest rates are not likely to spike,” he said.

But with the year-on-year inflation reaching a staggering 175,66 percent in June, there will be more pressure to put up interest rates. This points to a vicious cycle. What other options are there?

Can we still fight inflation with high interest rates? In the Israeli plan of July 1985, according to Guillermo Calvo in a Journal Article (Fighting Inflation with High Interest Rates), restrictive policy measures led to real lending and deposit rates in annual terms of 406 percent and 78 percent, respectively, during the first quarter of the programme.

In Argentina, major stabilisation plans such as the Austral (June 1985), Primavera (August 1988) and Bunge Born (July 1989) were all supported by high interest rates. But in Zimbabwe’s context, can borrowers cope with high interest rates without defaulting? The banking sector’s loan to deposit ratio is already very low, will this strategy not worsen things?

According to Calvo, in Argentina, for instance, high interest rates have usually been successful in reducing the premium in the short term, as they encourage the public to roll over deposits rather than buy dollars in the parallel market. Will this work in Zimbabwe, where will it leave the consumer and business?

Time will tell.


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