Nico asset managers cautions on rate hike

Nico Asset Managers Limited says monetary authorities’ adoption of inflation targeting method could result in another bank rate hike so that interest rates match inflation targets.

The investment advisory firm, in its economic review for June 2012, says inflation targeting method adopted by the Reserve Bank of Malawi (RBM) in April this year, could result in somewhat volatility in interest rates since they will be one of the instruments used to meet inflation target.

But the firm, however, says the use of other monetary policy tools such as repos, a repurchase agreement and liquidity reserve requirements (LRR)-the amount of clients’ deposit held with commercial banks at no interest-could maintain stability in interest rates.

The bank rate is currently at 16 percent, having been revised upwards by three percentage points from 13 percent on May 11 and inflation rate for May is hovering at 17.3 percent from 12.4 percent in April 2012 due to increases in both the non-food and food component, according to the National Statistical Office (NSO).

Following the bank rate hike, commercial banks increased their base lending rates on average by 3.1 percentage points to 20.8 percent, but the severe liquidity shortages have, in part, resulted in another hike in the average base lending rate to 23.5 percent.

But Nico Asset Managers Limited observes that high lending rates could result in reduced private sector investment and growth.

“High borrowing costs may also result in increased risk of defaults of existing liabilities. Investors are likely to be more willing to invest on shorter dated paper,” says the firm.

It says increase in rates on the money market may result in investor shift from stock market to money market as rates become attractive, adding that new debt offers will decline due to increased cost of borrowing.

An increase in the bank rate could result in a further increase in the base lending rates, a development that could increase the cost of loan repayments and regress private sector investment and growth.

“We may see the bank rate and consequently lending rates being adjusted upwards and downwards depending on the inflation target. Interest rates offered in the market could be more in tune with prevailing inflation rate figure,” says the firm.

Finance Minister Dr. Ken Lipenga, in the 2012/13 budget, has forecast an annual average inflation of 18.4 percent in 2012 from an annual average of 7.6 percent in 2011.

The soaring inflation figures of 2012 are mainly due to the devaluation of the kwacha which has resulted in higher fuel prices and other import costs. The removal of subsidies on fuel and utilities such as electricity will also contribute to the increase in inflation figures, said the firm.

Rising inflation, escalating the cost of living, will continue to erode purchasing power, resulting in lower disposable incomes and reduced savings.

On Monday, Blantyre-based Alliance Capital Limited  said monetary authorities will soon succumb to market pressure and adjust upwards the bank rate currently at 16 percent in view of the tight liquidity position, according to investment and portfolio managers Alliance Capital Limited.

Market insiders say because applicants of foreign exchange only do so with enough local currency locked in their accounts, most banks lent out the idle funds that were awaiting forex.

When the shock devaluation came and forex started getting available, banks could not mobilise enough kwacha with which to exchange. That explains the cash squeeze in the financial system.

The RBM has since responded by introducing a discount window borrowing at 18.5 percent for “stressed banks” to access and avert a liquidity crunch—a time when cash resources are in short supply and demand is high, a development that has pushed up bank’s lending rates.