But given the high levels of loitering liquidity in the financial system, raising interest rates could be a matter of “when” not “if” for the new Reserve Bank of Malawi (RBM) Governor Charles Chuka.
It may even be another necessary evil just as devaluing the kwacha is although the impact of the twin shocks on the economy could be devastating in the short term, but that could be another subject for another Saturday.
Chuka, who President Joyce Banda hired last week, is set to be the first RBM chief in about a decade to raise interest rates. He may do it in the first half of the 2012/13 financial year, most likely soon after Parliament enacts the next national budget.
Dr. Elias Ngalande, an academic, was the last monetary policy boss during the period to raise the bank rateâ€”the rate at which commercial banks borrow from the central bank and which traditionally is the benchmark against which the banks base their lending rates to the public.
Ngalande upped the bank rate from 40 percent to 45 percent in June 2003. he then progressively reduced the price of money to 25 percent by the time the then new President Bingu wa Mutharika, now deceased, fired him in February 2005.
The Liquidity Reserve Ratio (LRR) also fell markedly from around 27 percent in 2005 to the present 15.5 percent, leaving a larger fraction of deposits in commercial banks and less locked up at the RBM. Prior to June 2003, Ngalande raised the bank rate to as high as 75.5 percent in March 2001, before bringing it down as he tried to tame a snarling inflation rate. His successor, commercial banker Victor Mbewe, further cut rates to around 13 percent by the time Mutharika relieved him of his duties in July 2009.
Career economist Dr. Perks Ligoya, who replaced Mbewe in September 2009 and who President Banda sacked last week, never tinkered with interest rates.
Ligoya spent most of his RBM time grappling with the exchange rate policy, hunting for dollars and fielding dueling calls from the International Monetary Fund (IMF) and Mutharika who constantly clashed with the Brettonwood institution over the devaluation of the local currency, the kwacha. The late leader was against devaluation, saying it would trigger high commodity prices and hurt the poor.
But with devaluation almost a done deal and donor aid on its way, one policy headache will be out of the way, only to be replaced by the devaluation-induced and non-food inflation monster even as market analysts raise alarm on the fast rising liquidity levels.
The K30 billion bond, which hit the market in December 2011, was supposed to help mop up excess liquidity as authorities hoped to get investor cash in exchange for the long-term paper.
But with this tool getting lukewarm response from investors, uptake has been luckstre. Inflation has been rising since January 2011 from a single digit mark of 6.6 percent to 11.4 percent in March 2012.
As of last week, according to a report from investment and portfolio managers, Blantyre-based Alliance Capital Limited, liquidity shot up to K10 billion, a sharp 25 percent rise from K8.9 billion the previous week.
“Clearly, liquidity management remains a major challenge in the face of increasing kwacha balances due to unavailability of foreign exchange. Meaningful reduction in excess reserves is, perhaps, only achievable upon achieving reasonable inflows of foreign exchange reserves to settle the huge backlog of foreign bills,” explained the report.
The bottom-line is that the Malawi financial system has reached a liquidity glut whereby too much capitalâ€”thanks to comparatively low interest ratesâ€”is running after too few goods (including fuel, bread, sugar) and fewer still productive investment opportunities; hence, the recent surge in inflation.
The result could be that because of limited investment avenues, large amounts of money could desperately be put in bad investments, but these are destined to fail to pay returns, which may lead to high default rates on debts, followed by property repossessions and the panic that comes with the scramble to sell before prices fall further.
This explains why, as I read in a weekly business newspaper last week, property prices have gone up sharply across the country because, in the absence of better investment avenues, real estate seems to be a safe haven.
But what is happening on the property market could lead to a dangerous asset bubble, with the worst case scenario being irrational exuberance, which is even more dangerous.
Ask Americans how mortgage-backed securities during the subprime crisis that climaxed in 2008 wrecked Wall Street and caused the great global recession. This may sound far-fetched, but the trend is not very good.
Simultaneously raising interest rates and the LRR could help contain the bubble and stabilise the financial market.