Interest rates hikes exact high price in Africa

Rates are being increased across the world in response to stubbornly high inflationary pressures but this could produce a more conservative investment environment in Africa in particular, with financing for SMEs and large corporations crowded out in favour of sovereign lending.

At the same time, rising costs are adding to existing national debt burdens and it is difficult to predict when lending rates will come down.

The current high rates of inflation across the world are caused by a number of factors, including supply chain readjustment following the Covid-19 pandemic and much higher energy and staple food costs following the Russian invasion of Ukraine.

In March 2022, the US Federal Reserve (Fed) increased its main interest rates by 0.25% from a historic low range of 0.25-0.50% and has continued lifting them regularly ever since, most recently in March 2023 to 4.75-5.00%. Increases in interest rates by the Fed to depress US inflation can hit investment across the world because they encourage capital inflows to the US, often at the expense of developing countries.

The central banks of other industrialised nations have followed the same pattern, with the Bank of England raising its main interest rate from 4% to 4.25%, its highest rate for 14 years, responding to higher than expected inflation of 10.4% in the year to February.

UK interest rates were as low as 0.1% until December 2021. Despite turmoil triggered by banking sector uncertainty in general and Credit Suisse’s difficulties in particular, the European Central Bank increased the main Eurozone lending rate by 0.5 percentage points to 3.5% this March.

The South African Reserve Bank (SARB) actually began raising interest rates even before the Fed made its first move. Most recently, on 30 March, it increased its main rate by a higher than expected 0.5% to 7.75%, the highest level for 13 years.

The move was designed to bring inflation down to the target rate of 4.5% from the current level of 7% and also to defend the Rand as a result of the country’s widening trade deficit. South African inflation is partly driven by the same food price rises as the rest of the world but the worst power cuts in the country’s history are also having an impact.

Before the latest SARB increase, it had been assumed that this would be the last rate hike in the country for some time but the fact that the Monetary Policy Commission opted to increase rates by 50 rather than 25 basis points indicates that the SARB might decide to act again, despite the South African economy’s urgent need for investment, which higher rates can deter.

However, the rises could benefit South African banks, which have already enjoyed a strong recovery in profits since the pandemic and they remain well capitalised. Higher lending costs could drive profits up still further over the course of this year, although wider problems in the South African economy could act as a brake on bank business.

Rates rise across the board in Africa

The Kenyan central bank also surprised the markets in March by raising its benchmark rate by 0.75% to 9.5%, rather than the more modest 0.25% hike that had been predicted. As with the SARB, the Central Bank of Kenya’s main task is to contain inflation, which rose to 9.2% in February, but it also appears concerned about currency depreciation against the US dollar.

Indeed, recent protests by supporters of opposition leader Raila Odinga have not only been motivated by distrust of the government but by rising food and transport prices. The CBK left its key rate unchanged at its last meeting in January, so it seems clear that African central banks are more concerned about inflationary pressures than they were even at the start of this year.

The Bank of Ghana followed the trend by lifting its main interest rate from 28% to 29.5%, again a bigger jump than was expected, as Accra continues to struggle to bring its much more virulent inflationary pressures under control. This is a prerequisite for a promised $3bn IMF loan and much needed given that the annual rate of inflation stood at 52.8% in February, just off its peak of 54.1% in December.

Bank of Ghana Governor Ernest Addison said: “To place the economy firmly on the path of stability and reinforce the basis for disinflation, it is important that monetary policy stance is tuned firmer to re-anchor inflation expectations toward the medium target.”

Yet the rate has now increased by 12.5% in the space of just a single year. It would be easy to blame this on the impact of global rate rises feeding through but Ghana’s rate difficulties have far more to do with domestic developments.

The Central Bank of Nigeria also lifted its main interest rate at the end of March, by 0.5% to 18%. Aside from the same inflationary pressures affecting the rest of the continent, Nigerian prices will also be driven up if the government follows through on a pledge to end petrol and diesel subsidies, which cost Abuja about $10bn last year. Such a rate will surely deter borrowing but is well below the highest rate on the continent, 150% in Zimbabwe, and even this is down from 200% in February.

This raft of rate rises is designed to prevent the capital outflow that not only stems from the Fed’s actions but from the moderate global banking sector uncertainty that was triggered by the collapse of Silicon Valley Bank and the emergency takeover of Credit Suisse.

African central banks often also raise interest rates to protect their domestic currencies against the appreciation of the US dollar and to prevent their foreign exchange reserves from being run down. The latter have already been strained at Africa’s net energy importers by high energy prices.

Impact of higher African rates

As ever, however, there is a big difference between the level of benchmark interest rates in Africa and those in the industrialised world, with rates in South Africa, Kenya, Ghana and Nigeria ranging between 7.75% and 29.5%.

There has always been a big difference in lending rates between Africa and much of the rest of the world but the continued chasm is stymieing the ability of African commercial banks to lend to their
wider economies.

There is little doubt that the current combination of high interest rates and high inflation will deter investment. A high proportion of African bank loans are issued at floating or short-term interest rates, so sudden fluctuations have a big impact.

The risk of bad debts will increase, although probably not dramatically. African banks responded to Covid-19 by rebalancing their asset portfolios towards safer assets but rapid interest rate reductions and the implementation of liquidity measures meant that a severe reduction in lending volumes was generally avoided on that occasion.

The European Investment Bank (EIB) warned last year that African banks’ focus on sovereign lending could lead to ‘crowding out’ of private sector lending because government bonds are seen as a safer bet during unstable periods when higher interest rates make bonds even more profitable.

In a report late last year, the EIB argued: “The growing debt-financing burden faced by African governments may have put downward pressure on bank resources, which are then largely reallocated to finance government Treasury bills and bonds to the detriment of support for long-term private sector investment.”

There is also a fear that – as in the West – higher interest rates could expose vulnerabilities in the financial sector. World Bank Group President David Malpass warned: “We have seen that this rapid transition from low interest rates, abundant liquidity to higher interest rates and much less available liquidity has exposed vulnerabilities in the financial sector that make the task of policymakers even harder.”

However, the multilaterals believe that concern over inflation should take precedence. IMF Managing Director Kristalina Georgieva said: “Central banks do have a preoccupation to bring inflation down and it is paramount because, without price stability, there is no sound foundation for investments and for growth.”

She said that they can fight inflation by keeping interest rates higher for longer, while providing targeted liquidity if needed. African banks as a whole generally have a poor record in providing finance to SMEs, although it has slowly improved in recent years as more lenders have entered the sector.

However, the recent round of rate rises is likely to curtail SME lending, particularly where company data is limited, prompting the IMF and World Bank to issue a joint statement in April calling for policy makers in low income countries to provide dedicated SME financing. Singling out Nigeria, Malpass and Georgieva said that such intervention would help enhance inclusive growth and cushion the impact of high inflation and interest rates.

Once the current wave of inflation is tamed, the IMF forecasts that low interest rates will again become the norm in the industrialised world because of low productivity increases and ageing populations, as older people tend to spend less than younger people. This should help African central banks reduce their own interest rates but no-one should expect them to fall to the level of those in the West for a long time to come.