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Of Inflation and Interest Rates

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Of Inflation and Interest Rates

HARARE – In the United States, the Fed increased interest rates to try and control inflation. The Fed wants inflation to stay suppressed after rising to 2.7 percent. In Zimbabwe, the Reserve Bank of Zimbabwe is trying to cut down interest rates, to make borrowing cheaper, to encourage consumers to borrow, so that spending can increase.

In governor’s Dr John Mangudya’s own words in the 2017 monetary policy, “Affordable credit is very important to enhance output and productivity. Therefore, for the national economy to flourish, affordable credit must be provided to both large and small scale businesses and individuals to enable them to invest in productive activities that increase jobs, exports and reduce poverty”.

That is why the Reserve Bank of Zimbabwe is planning to cap the high interest rates currently obtaining in the markets to 12 percent on 1 April. But just two weeks before that day, America’s Federal Reserve Bank raised interest rates for the second time in three months. The key interest rate for overnight lending was increased from a range of 0.5 percent to 0.75 percent to a range of 0.75 percent to 1.0 percent. Two more hikes are in the offing this year, with three more expected next year.

How do we reconcile the two scenarios?

We have a case of two countries that use the same currency – the greenback – pursuing two different macroeconomic goals. The difference is that America owns the currency, and has the authority to print it, while Zimbabwe has no control over what can happen to it.

Just yesterday, as the Fed was raising rates, Zimbabwe’s February inflation rate took a huge swing, gaining 0.71 percentage points, to land at 0.06 percent. The market is already jittery about what inflation can do to the economy. “We see inflation emerging as a new economic challenge going forward”, Old Mutual Zimbabwe chairperson, Johannes Gawaxab, said in a statement accompanying the group’s financial statements this week.

Since the Fed’s rate rise has a contagion effect on Zimbabwe’s economy in general and the financial sector in particular, it is interesting to see whether the country is going to maintain its ‘price controls’ in the financial sector, or leave them to free roam.

The downside of allowing the rates to be flexible is that they will be raised to higher levels by players in the financial sector; thereby increasing the payments made by Zimbabweans who borrow money to finance different productive activities that keep the economy ticking. Yet fixing the rates will also mean that banks will be left stuck as their cost of borrowing rises, while their net interest margins are slimming, which further reduces their appetite to lend. Banks have already been going easy on lending, as their loans to deposit ratios declined significantly last year.

The ironic question is: Will trying to force interest rates down also not reinforce inflation up, to further erode people’s real income levels? Inflation is already rising substantially, as the effects of import substitution and the proliferating black market for the greenback start to kick in, and there is a fear that it might accelerate to the point of breaking the benchmark presumed acceptable.

Another worry is that the Fed’s rate hike will also cause the dollar to appreciate in value, which might affect Zimbabwe’s exports; the very exports which are the country’s main source of liquidity. It could also mean higher debt repayments for Zimbabwe, as a substantial amount of our external debt obligation is denominated in the greenback. Zimbabwe has an external debt of more than $7.5 billion.

As we wait for the actual outturn of all these developments, it is going to be interesting to see how Zimbabwe is going to navigate its way and the decisions it is going to make in order to enhance its macroeconomic fundamentals in the interest of economic growth and development.

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