Go slow with interest rate hikes, small businesses suffer when rates go up
By Josef Kefas Sheehama.
Namibia raised its key interest rate for the first time in six years, safeguarding its currency peg with South Africa’s rand. The monetary policy committee lifted the rate on Wednesday 16 February by 25 basis points from 3.75% to 4%.
The interest rate is an important economic pricing mechanism. This is because whether seen from the point of view of cost of capital or from the perspective of opportunity cost of funds, the repo rate has fundamental implications for the economy, in this case, potentially a negative impact.
My view is that the hike in interest rate is not appropriate at this time. Business and the economy are grappling with too many shocks already, which are increasingly becoming impossible to bear. The interest rate has become an additional burden for many businesses and the growing number of non-performing loans is posing a serious risk to the stability of the financial system. Furthermore, the economy is still and essentially bedevilled by the large size of an inefficient public sector, by low savings rates and investment, by persistent large budget deficits, and by an inconsistent macroeconomic environment.
These challenges underscore the need for policies that would stimulate the economy. I appreciate the concern about inflation, which informed the decision of the Bank of Namibia but the bigger worry is how to stimulate growth and rebuild confidence in the economy. I believe that private sector capital, both local and foreign, would respond positively if confidence is restored and more investment opportunities are created.
In the financial sector, banking institutions are dealing with new challenges such as loans restructuring and expected higher non-performing loans, subdued growth, along with more exposure to unproductive sectors. Positive expectations about returns on investment could offset short-term worries about interest rate rise.
Eventually, an increase in productivity would ultimately improve output and moderate inflationary pressure. In this regard, interest rates play a crucial role in the efficient allocation of resources to facilitate growth and development of an economy and as a demand management technique for achieving both internal and external balance with specific attention for deposit mobilization and credit creation for enhanced economic development.
Typically, the interest rate is expected to have either a positive or a negative impact on economic growth. Thus decreasing the interest rate due to expansionary monetary policy may stimulate the economy because of increased economic activities. On the other hand, slow economic growth which may be due to a tight monetary policy via a relatively high interest rate regime can lead to a fall in the economic growth.
The annual inflation rate in Namibia edged up to 4.6% in January 2022, up from 4.5% in December. Upward pressure came from prices of transport and food & non-alcoholic beverages amongst other items. As the Namibia Statistics Agency said, current inflationary pressure did not result from monetary factors; it is, therefore, unlikely that it could be fixed by monetary policy.
It is largely driven by the high transportation cost, and by increases in food and non-alcoholic beverages. Tackling inflation could only be effectively done within the context of these factors. It should also be acknowledged that monetary policy instruments cannot solve all the problems. It would be overambitious of the monetary authority to want to achieve this.
But despite my views, the Bank of Namibia did the right thing under the circumstances. If it failed to act, attracting investment would not be possible. But for businesses, the implication is that interest rate would go up, and the cost of borrowing would increase. This should be a thing of concern to us.
The business chamber should engage government to see how it could establish a special window for businesses to access funds at affordable interest rate. This is the only way out of the current challenge. We should set up more development funds in addition to the liquidity in the conventional financial sectors so that there could be cheap loanable funds for businesses.
Personally, I think it is too early to predict how the decision would affect the economy. It has to be tested first. But I don’t think it would do the economy much good. Some public policies appear good on their face value while their implementation may turn out to be counter-productive.
Increasing the interest rate means increasing the cost of borrowing. If the cost of funds goes up, local production is affected which is not consistent with the plan to increase local production.
A rise in interest rates would be a particular challenge for government, since interest payments are funded out of the operating budget and must be balanced each fiscal year. However, given the long-term nature of outstanding state and local debt, it will take a prolonged period of higher interest rates to seriously impact the budget.
In conclusion, inflation is not necessarily caused by excess money supply. In Namibia’s case, the current inflation is imported. It is a response to scarce foreign exchange. High inflation can be extremely damaging to both consumers and businesses. Fortunately, since we have not yet started to see a buildup of inflationary pressures, the Bank of Namibia can afford to act slowly, with small, incremental interest rate increases.