Commentary, 28th August - 4th September, 09

In the last few weeks, we have witnessed a sudden rise in bank base rates and this comes against the backdrop of dropping levels in inflation rates. In an economy where economic fundamentals are correct, the inflation and interest rates are directly related. This is not happening at the moment and it remains an indication that the current hikes in interest rates are not backed by expansion in credit demand but other factors that are not healthy to the economy. The base rates in US dollars now stand at 14 percent on average while base rates in Kwacha stand at 24 percent on average, reflecting an increase of over 15 percent, which itself is above inflation.

The pricing of any commodity is a reflection of the kind of information that the market holds. At present, two factors are driving the interest rates. The first is that the competition in the banking sector is not yielding the results that the government had projected at the time of allowing for further investment in the banking sector. The perception in Zambia has been that the country is under-banked and therefore needed additional players to push interest rates down.

Consequently, we have had new banks investing in Zambia but without any expansion in savings. In the absence of major economic expansion, the banks end up competing for the little savings that are already held by other banks. The strategy by the new banks is not to go for the unbanked market but decided to increase savings rates to pull customers from the existing banks. As a result, we are witnessing a situation where competition is not based on provision of new loans but on increasing the cost of liabilities, in this case, savings. The net result is that other banks are responding likewise and this is not healthy for the country because the savings themselves are not rising. The worst part of this strategy is that it has translated into huge increases in the cost of capital for borrowers, the private sector in particular.

The other factor is that the government has lately increased its borrowings. Its recent issuance of treasury bills was under-subscribed meaning that investors want higher yield rates. The government has no choice but to drive up the yield rates and this will imply banks have to offer better interest rates to attract investors away from government treasury bills.

There is not much liquidity in the country at the moment and while we celebrate the anticipated drop in inflation, the cost of doing business is rising and this requires serious attention. Worse still, it is not yet known how donors will react to the recent court judgments on issues of corruption, and the earlier they state their position, the better for the economy. In any case, the budget will be released in about six weeks and the level of donor support will certainly have a bearing on the interest rates, inflation and investor behaviour.