The National Bank of Rwanda (BNR) has recently started to move from a long cycle of monetary policy tightening in which the policy rate had increased by approximately 300 basis points for a period of two years as the bank worked to reign in rising inflation.

In May, the central bank started easing its monetary policy by reducing the policy rate, the key interest rate set by the bank’s monetary policy committee to guide borrowing in the economy.

The Monetary Policy Committee (MPC) of the National Bank of Rwanda cut its key interest rate by 50 basis points to 7 per cent in May, bringing it back to the levels last seen in August 2023.

Until August 2023, the MPC, which takes decisions on key interest rates, had increased the policy rate by 300 basis points in a long tightening cycle that was aimed at containing high inflationary pressures.

As a result, inflation declined significantly from 20.2 per cent in the first quarter of 2023 to 4.7 per cent in the first quarter of this year.

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When the committee initiated its cycle of monetary policy tightening, inflation was surging, commodity prices had spiked, and the cost of living had risen dramatically.

By raising the policy rate, the central bank aimed to increase borrowing costs for businesses and individuals. This strategy was intended to moderate economic activity, cool demand, and ultimately bring inflation back to target levels.

One way through which the central bank monitors the effectiveness of its policy decisions is through the interbank market rates, the key interest rates at which banks lend money to one another for short periods, typically overnight or for a few days.

The interbank market rate is crucial for banks to manage their daily liquidity needs and maintain required reserve levels, and as a result, be able to lend money to the economy without elevated risk.

"When we move our policy rate upwards, the interbank market rate moves upwards. By the time we started increasing, it was below 5%, until we reached above 8%. When we started reducing, it also started reducing,” central bank governor, John Rwangombwa, told The New Times in an exclusive interview.

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When the central bank reduced its policy rate to 6.5 per cent in the last monetary policy round, the interbank rate immediately started reducing, reaching 7.32 per cent in August.

"The movement in interbank rates is 100% linked to our policy rate decisions, which is a good sign that at least we see some transmission of our monetary policy,” he noted, adding that short-term money market rates, including interbank and treasury bill rates have followed suit since the bank shifted its policy.

The interbank rate witnessed a decline from 8.21 per cent in the first half of the year to 7.32 per cent, falling below the 7.55 per cent level recorded in the same period of 2023.

Interest rates direction

Despite the central bank’s monetary policy adjustments, lending and deposit rates have not fully aligned. The governor said the discrepancy is expected, given the relatively young and less developed nature of Rwanda's financial sector.

"Long term government securities adjust with the lag. The same with deposit rates,” he said, suggesting that the central bank is aware of the time lag between policy rate changes and adjustments in long-term government securities and deposit rates.

The two years of monetary policy tightening have seen the government yields of treasury bonds increase. In the first half of 2024, 3-year bond yield increased to 11.57 per cent from 10.85 per cent. Five-year bond yield increased to 11.99 per cent from 11.76 per cent.

The rise in bond yields, which represent the return an investor receives, is a result of an increase in policy rate. Investors are technically demanding a higher return on government bonds because the central bank has made borrowing more expensive.

Deposit rates, too, have started increasing this year, based on central bank’s policy decisions in the past two years. The average deposit rate stood at 10.24 per cent in the first half of 2024, compared to 9.48 per cent in the same period last year.

"The lending rate is sticky, so it takes time to adjust. But because all the other rates have adjusted, if we had maintained the tight conditions, we would have seen the lending rate also follow,” Rwangombwa said.

In the first half of 2024, the lending rate saw a slight decrease of 3 basis points, moving to 15.68 per cent from 15.71 per cent in the first half of 2023. The central bank attributed the slight reduction to a greater proportion of short-term, large corporate loans in the lending mix.

Rwangombwa said that with accommodative conditions that we have started, the central bank doesn’t expect to see the lending rate increasing, although he maintained that this will not happen overnight.

He also highlighted that when the central bank started increasing their rates in 2014, the policy rate was at 7% before reducing to 4.5%. The lending rate was then 17.5%, but it has gone down slowly up to 15.68% currently.

ALSO READ: Rwanda central bank lowers policy rate to 7%

Inflation

The central bank’s war on rising inflation seems to be paying off. Headline inflation, a key metric which tracks the average change in prices for a basket of goods and services that a typical household consumes, hit 20.7 per cent in January of 2023.

Headline inflation has since dropped, reaching 5.1 per cent in the second quarter of 2024.

The central bank anticipates inflation to remain around 5% for the remainder of the year, well within its target range of 2-8%. This forecast is supported by the stabilisation of food and core inflation, coupled with the expectation of declining global inflation pressures easing energy price increases.

"Everything looks okay for the year and next year. We can only have problems if we experience unfavorable weather conditions and, therefore, impacts on projection on food inflation,” he said.

The central bank has flagged global trade disruptions, particularly those stemming from geopolitical tensions like the ongoing wars in Ukraine and Palestine, as potential risks to Rwanda's economic growth. These disruptions could disrupt supply chains and lead to increased domestic commodity prices.

Rwangombwa asserted that despite the challenges posed by the COVID-19 pandemic and the war in Ukraine, public trust in the economy is gradually being restored as price stability returns.

ALSO READ: Economic Growth momentum expected to continue in 2024

Franc depreciation

One major concern that every economist has expressed is the continued fluctuation of the Rwandan franc against the United States Dollar. In 2023, the franc depreciated 18.05 per cent against the USD.

Despite the increase, the governor relayed fears, saying the continued fluctuation of the franc against the USD does not in any way imply the economy is struggling.

"We are candid with our economic situation. We expect to see the depreciation continuing, but it doesn’t affect the long-term economic growth of the country,” he said, adding that the depreciation has been happening for the last decade and the economy has continued its growth trajectory.

The governor maintained that there is a need to allow the Rwandan franc to find its footing based on market conditions, rather arguing that "you don’t want to tie the currency to make it uncompetitive on the global scene.”

As Rwanda improves its export base and domestic production, Rwanda said he was convinced that the franc value will remain intact for the time being and stabilise in the future.