BoB interest rate hikes: Who gains and who loses?
Aobakwe Setso Motang - Lovemore Taonezvi | Monday July 18, 2022 06:00
In April, the BoB increased the newly introduced Monetary Policy Rate (MoPR) by 51 basis points (0.51%) from 1.14% to 1.65%.
The latest increase is 50 basis points (0.5%) and takes the MoPR to 2.15%. The MoPR is the rate at which BoB lends money to commercial banks. It affects the prime lending rate which is the rate at which commercial banks charge consumers for borrowing money. The prime lending rate is higher than the MoPR to enable banks to cover their basic profit margin.
According to BoB, the rationale for the interest rate hikes were rising inflation expectations driven by domestic fuel price increases; import restrictions; rising commodity prices, especially of oil and food; forecasted depreciation of the Pula against the South African Rand; and increases in domestic transport fares. In line with expectations, figures released by BoB showed that actual inflation reached 10.4% in the first quarter of the year. Furthermore, inflation accelerated from 9.6% in April 2022 to 11.9% in May 2022, a level which is above the central bank’s medium-term objective range of 3 – 6%.
Therefore, the economy is operating in an environment of rising inflation. To curb the high inflation rate, the BoB undertook a contractionary monetary policy through interest rate hikes to reduce the economy’s liquidity and aggregate demand. The issue of rising inflation has quickly become a global phenomenon. The United States of America also increased its repo rate by the highest margin in 21 years to tame accelerating inflation. Botswana’s trading partners South Africa and Namibia have also recently increased their interest rates in response to rising inflation.
While moderate inflation, that is, inflation within the Bank’s medium-term objective range, is beneficial to the economy, high inflation rates have a myriad of devastating effects.
Among other things, high inflation erodes consumers’ purchasing power, reduces the value of pension savings, diminishes the value of fixed income investments, discourages saving, depreciates the Pula, and exacerbates poverty. Concisely, high inflation degrades the socio-economic wellbeing of Botswana’s populace. Considering these undesirable consequences of inflation, the Bank has resorted to increasing interest rates since, in theory, an interest rate hike culminates in the deceleration of the inflation rate.
The BoB is likely to continue raising the interest rate in its three remaining Monetary Policy Committee meetings for this year scheduled on 25 August, 20 October, and 1 December. Expectations of further interest rate hikes are based on a multiplicity of factors which will further exert an upward pressure on inflation. According to BoB, these factors include: “the potential increase in international commodity prices beyond current forecasts; persistence of supply and logistical constraints to production; the economic and price effects of the ongoing Russia-Ukraine war and the uncertain COVID-19 profile; ... effects of the recent increase in public service salaries, administered prices and inflation expectations.... the likelihood of further increases in domestic fuel prices in response to persistent high international oil prices....”
Interest rate increases impose positive and negative effects on the economy and its participants. Consequently, there are winners and losers from such increases.
Firstly, an increase in interest rates increases the cost of borrowing money from banks and this tends to reduce both investment and consumption spending. Secondly, borrowers with loans and credit cards whose interest rates are linked to the MoPR will see their interest payments increasing. Both these effects disadvantage consumers who depend on credit facilities to fund their spending.
Furthermore, the resulting increase in interest payments also reduces the disposable incomes of consumers. Entrepreneurial activities are also adversely affected by the increased cost of obtaining capital from banks and this reduces investments in the local economy. This then negatively reduces employment opportunities of which Botswana’s unemployment is around 26%. The net effect of these factors is to reduce economic growth. In 2021 economic growth was 11.4% while growth estimates for Botswana by the April 2022 World Economic Outlook for 2022 and 2023 are 4.3% and 4.2%, respectively. The recent interest hike will most probably cause a downward revision of these growth forecasts.
Thirdly, an increase in interest rates boosts the return on low-risk financial assets such as bank fixed deposits, money market mutual funds, short-term treasury bills and certificates of deposits. Therefore, consumers will be incentivised to reduce spending and increase their savings with the expectation of a higher future income. On the other hand, increases in interest rates tend to reduce stock prices and their respective earnings, thereby disadvantaging those directly and indirectly invested in stocks. The increase in saving and reduction in earnings from stocks reduces consumption and thus puts a downward pressure on inflation.
Fourthly, an increase in interest rates will attract short-term foreign investments (hot money) into Botswana as foreign investors seek to take advantage of the relative improvement in yields on Pula-denominated financial assets and this will consequently increase the demand for the Pula. However, the appreciation of the Pula will make the country’s exports expensive while making imports cheaper. Hence, exporters’ earnings will decline as demand for their products decrease. This in turn reduces employment in the export-oriented businesses. Batswana will increase their demand for the now cheaper imports and have more product choices and lower prices, thus an increase in their economic welfare. The net effect of the Pula’s appreciation will be a reduction in domestic consumption and inflation.
Fifthly, higher interest rates have an impact on the property market. With interest payments on loans increasing, the demand for properties decreases thereby putting a downward pressure on property prices. As a result, those buying properties stand to benefit while those selling properties tend to lose during periods of rising interest rates.
Finally, an increase in interest rates increases the Government of Botswana’s debt servicing costs since interest payments on government debt are determined by the country’s prevailing interest rates. This has the potential to increase the taxes as the government may seek to increase its revenue earnings to enable it to keep up with the increased interest payments. Consumers typically bear the heaviest burden of such increments in taxation.
*Lovemore Taonezvi (Ph.D. Economics, Economics Lecturer at BA ISAGO University) and Aobakwe Setso Motang, Business Management Lecturer at Botswana Accountancy College