Interest rates ineffective in containing inflation

PHILLEPUS UUSIKU

The cost of borrowing money in Namibia is expected to increase. All three analysts contacted by Market Watch expect a 50 basis points (bps) increase in the repo rate ahead of the monetary policy announcement by the central bank on Wednesday.

That will see the repo rate increasing from 4.25% to 4.75%, and the prime lending rate jumping from 8.0% to 8.5%.

According to Simonis Storm economist Theo Klein, the Bank of Namibia (BoN) will be deliberating the next interest rate move in the midst of the ongoing war in Ukraine which has caused global food, fuel, commodity and logistics prices to move higher, adding pressure to Namibian household budgets

“At the same time, a narrowing interest rate differential between South Africa and the US has been one of the factors leading to a weaker Rand/US dollar exchange rate in recent weeks. A weaker Rand is inflationary in itself for a country with a high import requirement such as Namibia. If interest rate hikes in the US outpace rate hikes in South Africa, we can expect to see a weaker Rand and therefore higher inflationary pressure in Namibia as a result,” Klein said.

Commenting on whether interest rates is an effective tool to contain inflation, especially now that it is driven by supply factors, Cirrus Capital head of research Robert McGregor says with reference to Namibia, the matter is different.

This is because unlike many central banks, the Bank of Namibia is not primarily an inflation-targeting central bank. While price stability is one of its concerns, the currency peg tends to take primary focus – and in that way also provides some indirect level of price stability. This is because it creates a closer link with South African inflation, where the South African Reserve Bank (SARB) is an inflation-targeting central bank.

McGregor notes that the close relationship between Namibian and South African inflation has weakened somewhat over the last four years.

The inflationary pressures Namibia currently faces are largely imported, driven by global food and fuel prices. Domestic monetary policy has little, if any, effect on these.

Developed markets

“Monetary policy elsewhere will prove more effective, such as in the developed markets. Much of the inflation we are seeing elsewhere in the world, which is also at rates higher than in Namibia, is demand-side driven. Extreme pandemic-related monetary and fiscal support drove substantial increases in demand such as through ‘stimulus checks’, and although supply issues were also present, the rapid and significant increase in demand has played a leading role in the higher inflation,” McGregor said.

IJG Securities head of research Danie Van Wyk said while it is mostly supply-side factors driving inflation at present, the SARB is attempting to maintain a balance by hiking rates, given that most central banks in developed markets, which are generally much safer investment destinations are busy doing so. By not following these central banks in raising rates, South Africa is likely to see an outflow of capital which will weaken the rand, which is in turn inflationary and will just exacerbate the increase in inflation.

Klein noted that it never made sense to hike interest rates in the Namibian context, given that consumer spending and credit extension has not grown by unsustainable rates since the pandemic outbreak. “We do not have overspending and rising wages that overheat the system and cause inflation to edge higher such as in the US. Rather, we have been arguing that interest rate hikes can assist in limiting exchange rate depreciation to some extent. If we have higher interest rates in South Africa or Namibia compared to advanced economies, the carry trade return on the Rand could be attractive and keep foreign capital within our borders. In this way, exchange rate ­depreciation can be limited to some extent. We see this as a rationale to hike interest rates although inflation is primarily driven by supply side factors.” [email protected]