Does Malawi benefit from policy rate decline

For the most part of 2016, The Monetary Policy Committee (MPC) of the Reserve Bank of Malawi (RBM) held the policy rate –the rate at which it lends to commercial bank – at 27%, until early November when the MPC reduced it to 24% with inflation downward pressure.

Kwacha

With continued downward pressure on inflation, mainly due to better food harvest, the MPC further reduced the policy rate to 22% around end March, this year. Recently, as the country has experienced a bumper yield this year, and hence with continued declining inflation, the MPC further reduced the policy rate to 18% from 22%.

This is in a bid to lower the borrowing cost of funds because the lower cost banks can access funds from RBM as lender of last resort, the cheaper they can also offer to their customers, and the entire population benefits from the improved economy which results from cheap availability of investment capital, employment and purchasing power of the people due to cheap access of such money. Therefore, this development has been received with applause from the public and has come at a time when Malawi has registered its lowest inflation rate in the past 5 years.

Normally, the move by the MPC is deemed as an expansionary monetary policy because the reduction in the policy rate entails that banks can borrow from the RBM at a lower cost, which may in turn make them reduce their base lending rates. In principle, the implication of this is that loans can be accessed at a lower cost from the commercial banks by individuals, firms and even government departments.

Therefore, this eventually acts as a motivation for investors to borrow more money and invest it. Furthermore, not only does this move increase money supply in the economy, but also increases its growth through an increased investment, production and also the ability of the people to demand and purchase commodities. This increased production -emanating from increased investment, resulting from low cost of capital ignited by policy rate reduction- meets the needs of increased demand which resulted from declining inflation which was also a motivation for policy rate reduction in the first place.

In the long run, with increased demand, increased investment and increased production, according to Keynesian economics, the economy grows. The reduction in policy rate, therefore, as it entails a high money supply, also leads to an increase in demand for foreign currency since the people have an easy and cheap access to the local currency with which to demand foreign currency.

But the question could be, will this be the case for Malawi? Will Malawi experience a real and significant economic growth? Given the lowest inflation level in the recent five years, and perhaps going towards the lowest policy rate in the five years, how do economic (GDP) growth rate projections for this year compare with those achieved in the past five years? Is it the economic scenario elaborated above not more of a theory than practical for Malawi?

To answer these questions, a critical analysis of the economy of Malawi has to be done, and in the end determine whether the reduction in policy rate can and will indeed yield its desirable results as theory postulates.

Firstly, the inflation has been on a deceleration trend from the last quarter of last year to date, with our latest inflation figure for the month of June being 11.3%. This is desirable news everyone’s purchasing power increases, given the constant amount of earnings.

According to the MPC minutes, the economic growth looks promising as it is projected to rebound to 4.5% this year from 2.7% in 2016. And since the Liquidity Reserve Ratio (LRR) has been maintained at 7.5% since the year 2015, this means that banks can still allocate more money to productive use such as giving it out in loans and mortgages rather than just holding it idle as reserves. This means that, Malawi being a predominantly an importer country, there is more strength of muscleadded to the local currency to support the purchase of foreign currency for importing goods.

With this kind of an economy, it can be said that the effects of the reduction in the policy rate by the MPC will be economic growth stimulating as it will not be rendered a redundancy by other macroeconomic factors such as the exchange rate which has been more stable than fluctuating for the rest of this year.

According to this analysis therefore, stability and improvements in several dimensions of the economy will be eminent, and that will aid the expansionary policy adopted by the MPC. In this case, we can safely argue that the reduced policy rate will result in increased economic growth (as projected at 4.5%) through increased borrowing resulting into more investments in areas such as purchase of machinery, industrial materials and creation of new other businesses. This further creates more employment, increase the purchasing power and productivity of people and capital in the economy, all else remaining constant. Hence, the policy rate reduction is economic growth stimulating.

This policy rate reduction, however,can also bring about inflation as it is expected that with lower interests followed by increased borrowing, comes increased money supply in the economy, thus inflationary. But the practicality of things is that increased money supply is not always inflationary, it matters what the borrowed money has been used for. If the money borrowed will be used for purchase of commodities for consumption, then it will indeed be inflationary as it will lead to increased demand for consumables.

However, if the money will be invested through purchase of machinery, industrial materials and used to boost various businesses -which is in the benevolent interest of lenders- it will in turn accelerate growth, create more employment, increase the purchasing power and increase productivity, all else remaining constant, thus economic growth stimulation occurs.

Furthermore, while it is true that some would also borrow to buy consumables due to low rate in which case this only adds up to the already increased demand which resulted from inflation drop, one important thing should not be ignored here: that this increased demand will meet increased production as a result of increased investment. That means high demand will meet high supply. As a result, the two eventually cancel without creating further inflation.

Furthermore, it must also be pointed out that it is the abundance of food commodities that has contributed highly to the continuous deceleration of inflation. This being the case it is illogical to expect that rational being will be borrowing money for the purpose of purchase of food commodities which is already in plenty, and has diminishing marginal utility. It further has to be emphasized and put to notice that loans are always expected to be repaid with cash inflows and this puts irrationality on borrowing for purchase of consumables which do not bring in any cash inflow just because money has become cheaper.

Not ruling out completely this possibility however, but the impulse of it on people is almost insignificant to count it in as a threat for upward inflation pressure. Therefore, it is more rational to argue that people will borrow lesser to purchase consumables than they will do for investments. As such, it is expected that economic growth will be stimulated more to curtail any inflationary pressure created by the increased money supply.Therefore it is safer to conclude that, all else being equal, this reduction in policy rate will be economic growth stimulating.

  • The authors studied Economics at Chancellor College. They work for Malawi Confederation of Chambers of Commerce and Industry, and they like commenting on socio-economic issues.
Follow and Subscribe Nyasa TV :

Please share this Article if you like Email This Post Email This Post

More From the World

More From Nyasatimes