There is a unique correlation between savings and interest rates. I track back to a news reporter’s take using the analogy of a banana. If you held a ripe banana right now, that would be representative of your savings. When prevailing interest rates are high, you could take this banana (Savings) to a bank and get more after a period of time. This is as a result of growth in the value of your savings due to attractive high savings rate. On the flip side, if the prevailing interest rates are low, to the extent of being negative, taking your banana to the bank would mean getting less its value after a period of time.
This simple narrative helps to show the impact of high or low interest rates to savings. However, interest rates also affect other areas including the cost of borrowing and the total return on investments. When interest rates are high, borrowing becomes expensive due to higher interest payments. Also, high interest rates imply more return on investments in an economy. These high interest rates incentivize investors from countries with lower interest rates to invest in the higher interest rate economy, as they would get more returns.
Interest rates have become an important tool at the disposal of central banks in influencing money supply and consequently, economic performance. When there is high inflation in the economy, central banks tend to increase interest rates to reduce overall money supply. On the other hand, when there is a slowdown in economic growth, central banks will lower rates to encourage borrowing and consequently increase spending and consumption to spur economic growth.
Historically, East African countries have had higher interest rates as compared to other major global economies. Kenya and Uganda, for instance, have had relatively higher interest rates because their central banks have looked to protect their currencies from depreciation according to CNBC Africa. Depreciation of currencies often occurs when a country has lower interest rates, which means lower currency value, making imports expensive and exports much cheaper. A manager from PwC Uganda also cites higher interest rates in Uganda as a reflection of high cost of doing business in the country, the country’s risk rating from an investor perspective and the government’s policy with regards to borrowing from the local market (PricewaterhouseCoopers, n.d.).
|Countries||Real Interest Rates %||Lending Rates %||Deposit Rates %|
With the overall slowdown in global economic growth, major central banks have looked to boost their economies through lower interest rates. Theoretically, lower interest rates should encourage borrowing by individuals and corporations and conversely, increase spending and consumption which would drive economic growth upwards. However, some countries have lowered their rates to the extent of reaching negative levels. Such countries include Japan (-0.10%), Sweden (-0.30%), Switzerland (-0.80%), and Denmark (-0.70%) (Picardo, n.d.). Negative interest rates imply that, people would save less with banks since in essence, their money would reduce instead of increasing (recall the analogy of the banana). The desired benefit, however, is that people will spend more which would drive consumption.
As shown in the table above, East African countries often lean towards high interest rates compared to other global economies. On paper, this would mean that individuals and corporations in East Africa earn more on savings and pay much more on loans taken from financial institutions. Moreover, higher interest rates should imply higher currency values for East African currencies since the high rates would demonstrate high confidence with the domestic currency. Regardless of these expected positive theoretical outlooks, East African countries have still struggled to grow their economies exponentially while also maintaining strong domestic currencies. Below I therefore look at some advantages and disadvantages that would be faced by EA countries if they were to lower the rates, low enough to be close to negative rate horizons.
Lowering interest rates would help, at least theoretically, spur East African economies especially during this pandemic. As mentioned earlier, interest rates form one of the levels that central banks can manipulate to favor their economies. As people continue to stay at home during this pandemic, economic performance is subdued which could mean that long term effects on the economy could be severe. In fact, some central banks have already slashed their central bank rates to encourage borrowing and consequently spending. According to Trade Economics, The Central Bank of Kenya on March lowered its Central Bank Rate by 100 bps to 7.25% to soften the risks associated with the global pandemic (“Kenya Interest Rate | 1991-2020 Data | 2021-2022 Forecast | Calendar | Historical,” n.d.).
Lower interest rates could also contribute to lower currency values whose major benefit would be cheaper exports. When exports increase at a higher rate to increased imports, balance of trade also improves which helps boost a country’s economic growth.
Small and Medium Enterprises could also benefit from improved cash flows as they will be making lower interest payments to their lenders. It is known that SMEs are central to East Africa’s economies. In Kenya, for instance, small & medium businesses account for 80% of job opportunities according to CNBC Africa. Therefore, when these businesses have access to cheaper credit, they can perform well and boost their cash flows.
Lower interest rates would discourage savings. This would hurt banks since their main source of revenue is generated from interest on loans issued. A portion of these loans comes from depositor’s savings which if they reduce, banks will have less money to lend. Individuals and corporations will borrow more. While this could increase spending, there is also the possibility of the money being stored, rather than spent for emergency situations. Also, very high levels of debt in economy and in businesses is risky and dangerous.
Given this COVID-19 pandemic, it’s almost inevitable that central banks, including the ones in East Africa, will reduce their rates even further, mainly to support their economy through increased spending. While the advantages are many, there could also exist undesired consequences. Yes, our economies need a certain level of stimulus, especially considering the level of informal employment in our countries. However, East Africa’s governments and central banks should strategize wisely such that the benefits outweigh the negatives. Furthermore, East African countries having higher interest rates could attract more foreign investments from countries with lower interest rates, which would still boost the domestic economies.