Dr Sanderson Abel
An interest rate is the compensation for the service and risk of lending money. Broadly defined, it is the cost of borrowing money. Interest rates are normally set using the market forces of demand and supply. The equilibrium interest rates are determined by the demand and supply of loanable funds in the economy. In some instances, authorities intervene in setting interest rates though this is perceived to be distortionary.
The equilibrium interest rates are dynamic and depend on the different types of loans offer, the risk profile of the underlying borrower, the tenure of the loan. In Zimbabwe various interest rates are currently obtaining owing to the fact that there are various players who are involved in the determination of interest rates in the economy without any guiding principle.
Among these are the central bank, depositors, investors, local and foreign banks, and micro-finance institutions.
The Central Bank through Monetary Policy, is supposed to give general direction on interest rates for the purpose of either increasing/decreasing economic activity and or to control inflation.
In other words, the Central bank is supposed to set the benchmark interest rate, which would guide all other interest rates. However, in Zimbabwe this is not case because since the adoption of the multi-currency regime, the Reserve Bank of Zimbabwe has little leeway to inject liquidity into the system in order to influence interest rates. That’s one of the weaknesses of dollarised economies. The lack of access to the levers of monetary policy means that the Reserve bank is left with moral suasion tools and directives on interest rate caps as avenues to influence the level of interest rates. It is in light of this that interest rates have become a controversial subject in the country with various players blaming the financial institutions of sabotage through high interest rates on lending. This remains debatable.
In the main, the short term and transitory nature of deposits in Zimbabwe has brought challenges for financial institutions in terms of being able to offer and sustain long term facilities at competitive rates. This is compounded by the fact that banks have therefore to maintain very high liquid asset ratios on their balance sheets, which impacts on the ability of banks to price long term facilities competitively. This is further compounded by structural challenges in the economy among which are the levels of provisioning and the perceived country risk. This also bears an effect on the interest rates.
Since 2013, the Central Bank has been playing a key role in the setting of interest rates. In October 2015, the Central Bank intervened and came up with a three tier interest rate for the productive sector and separate interest regime for the consumptive lending as shown in table below:
What can be perceived from the figures above is that the Central Bank in setting these rates was greatly influenced by the risk, mostly the credit risk element. What remains the central question becomes, how did the Central Bank determine the minimum interest rate of 6 percent and is it prudent to perceive it as the benchmark interest rate? Further there are a number of indicative rates obtaining on the market. These include interest rates being charged for different facilities by different players but impacting on the banking sector. The various facility being offered by the Central bank are charging interest rates almost closer to 6 percent which is in tandem with the minimum interest rate that was set by the Central Bank in 2015.
A review of the regional rates could also shed light on what’s happening elsewhere closer to home. The main weakness of regional comparison is the idea that regional countries have their own currencies while we are using a multi-currency system. Hence regional countries can manipulate their money supply to achieve their desired interest rates. The table bellows shows the benchmark interest for a couple of regional peers.
The table shows that save for Zambia and Malawi, the regional benchmark interest rates range between 5.5 percent and 7 percent. Zambia and Malawi are fighting high inflation rates which has led to these high benchmark interest rates. Unlike these two countries, Zimbabwe is a low inflation country having registered negative inflation rates previously for almost twenty seven months.
As best practice there is need for the Central bank to work towards establishing a benchmark interest rate. This would involve re-looking at the maturity profiles of the TBs in issues and trying to profile them so that they guide the market in establishing benchmark interest rates. This would then establish the optimal lending interest rates in the economy which do not suffocate industry. The whole process is not an easy task but will depend on a number of factors.
The trading of the Treasury Bills should be under an auction system which will allow the market to set the benchmark interest rate hence allow the market to correctly price itself. All the Treasury Bills on offer need to be re-looked so that all inconsistencies are removed through recall and reissue. Treasury should fully recapitalise the Central Bank and continue monitoring the adequacy of the capitalisation levels to ensure the bank plays the lender of last resort function and therefore influence market direction through monetary instruments such as the Repo rate.
The current liquidity ratio imposed on banks by the Central Bank reduces the amount the banks are able to lend out. This constraint has the effect of a high reserve requirement, which is to reduce the supply of loanable funds. The level of NPLs need to be kept in check because the credit risk element is a major cost driver of interest rates. Current initiatives should be buttressed at the regulatory and financial institution level
Dr Sanderson Abel is a researcher and economist. He writes in his personal capacity. For your valuable feedback and comments related to this article, he can be contacted on [email protected] or on 0772463008.