The National Bank of Rwanda has announced its decision to increase the key repo rate, the policy rate it applies on the money market, from 5 to 6 per cent in a bid to tame soaring inflationary pressures. The key repo rate represents the lowest rate at which the Central Bank charges commercial banks and the maximum rate at which it borrows from commercial banks. It is reviewed and announced to the country’s banking system, and the public, by the Monetary Policy Committee of the Central Bank every quarter and when necessary. For over a decade, the Central Bank had not increased its rate that high. The last such hike was in May 2012; from 7 to 7.5 per cent. On Sunday, August 14, barely a week after the Central Bank announced its decision, Prof Kasai Ndahiriwe, director of the monetary policy department at the Central Bank, spoke to Doing Business’ James Karuhanga, and shed light on, among others, the background, as well as how the increased Central Bank rate will actually tame inflation. The excerpts:First, economists define inflation as a rise in the general level of prices of goods and services, over a period of time. Please break it down for us; how can you define it in simpler terms? Inflation is the speed of the change in prices in percentage; which means that if I use the ideal level of 5 per cent, when we say that we want inflation to be around 5 percent we mean that a good or service, on average, which is at a price of Rwf100, next year, same time, same month, it should not be above Rwf105. An increase of Rwf5 is reasonable. Inflation figures are published on a monthly basis. But they always refer to the corresponding month of the previous year, which means that it is about a change in 12 months. What’s really the background then; why the increase? We are tightening because inflation is high. We haven’t really increased the central bank rate for a long time. It’s been more than a decade. We’ve just started. The last time we had the MPC [Monetary Policy Committee meeting]; we increased the Central Bank rate in February. In February we increased the Central Bank rate from 4.5 to 5 per cent. That was the first hike since, I think, more than a decade. Before that, we were decreasing the rate because of the conditions that prevailed. How do you explain that long period without such hikes? The reason is that in the past decade, inflation was at a desired level most of the time. It was close to 5 per cent. The objective of the National Bank of Rwanda is to have an inflation which is around 5 per cent. We say that 5 percent is our inflation benchmark. For the last decade, inflation was sometimes slightly above or below but on average it was close to that level. There was no reason to tighten; and, actually, there was reason to loosen the monetary policy stance because there were no inflationary pressures. Even when inflation went slightly above 5 percent it was mostly due to weather conditions that were temporary. When they are temporary, we know that once weather conditions return to normal, inflation will again stabilize and in that case, we don’t need to tighten because we know that it’s a shock for one or two quarters coming from weather conditions. It means that agriculture production is not sufficient and prices are increasing because there is shortage of supply. What is different this time? This time it is a combination of weather, the Ukraine crisis and the post Covid-19 global economic recovery situation. That recovery is actually the main reason for the inflation. The Covid-19 impact was there even before the Ukraine crisis erupted and before weather conditions in the country impacted. We had already projected that inflation was going to be high. That was why we tightened in February and at that time, the war in Ukraine was yet to start. Inflation was not very high but we tightened because projections were showing that in the coming quarters, inflation was going to be high because global demand was increasing faster than the production. During Covid-19 there were different support measures be it monetary or fiscal and this helped the global economy to recover quickly. But production did not catch up at the same pace which implied that there was a mismatch between demand and supply, which means that prices were foreseen to be high in these quarters. It was foreseen. At that time the National Bank of Rwanda tightened yet inflation was still at 4.3 per cent. Generally, people seem to have been taken by surprise by this tightening ... Yes; some people, even economists... No one was expecting to see a tightening decision because inflation was at a desired level. But a monetary policy decision is forward looking. The decision is not taken to affect the past. It is taken to prevent (unwanted events in) the future, or to set the ground for a better future. Why didn’t you tighten in May? In May we didn’t tighten, for one reason. Inflation had already started to rise but there was a new shock which brought uncertainties; the Ukraine crisis. Projections couldn’t show the impact of the war because no one knew that it was going to take this long. No one knew that there were going to be sanctions at the rate we are seeing. There was uncertainty. We couldn’t react given that uncertainty. We thought that things would get better soon but that didn’t happen. And then the weather conditions in Rwanda at the time were not favourable to the economy. But given that it was supply shock inflation, we decided to tighten when we saw that it has a second round effect. At that time our projections were not showing that there was going to be a spiral of inflation. Even other components that are not directly affected by those three reasons have started to follow that bad trend. Now, the decision is to tame the inflation in the coming quarters so that it (inflation) can come back to its desired level of 5 per cent going forward. And projections are showing that in the second half of 2023, we will be around 5 percent. How has inflation been going up? Headline inflation, year on year, was 5.9 per cent for quarter one of 2022. In quarter two it was 12.1 per cent, and in July 2022 it was 15.6 per cent. So, how will increasing the Central Bank rate really stop inflation from soaring? When we talk of the rising of the Central Bank rate, or any other interest rate, it means that money is becoming very expensive between banks because they borrow from each other at a higher rate. When the interest rate increases, money is becoming expensive, or scarce. We are not happy about it. But given that the projection is not showing good levels of inflation in the coming three quarters. Then, we have a choice; we either keep the Central Bank rate at the previous level and then remain with that high level of inflation or raise the Central Bank rate, make money scarce and expensive between commercial banks so that people can be interested in saving and only do necessary spending. This means that when people start choosing what services and goods to spend on and which ones to put on hold, that is going to reduce inflation because the demand is going to reduce and there will be focus on basic needs because money is going to be expensive and we use it more wisely than when it’s cheaper. Another element is that you are now being encouraged to save at a higher rate. If you save at a higher rate then you are sensitized to save the balance that you have in banks for a better deposit rate. It is a stimulus to save more because the saving rates are high. If you spend you will be foregoing that good deposit rate. It is like we are raising the awareness of people that money is becoming expensive and therefore, please, spend wisely on things that you think are really necessary for the moment. We are encouraging Rwandans to be more financially cautious. That is the path because when they reduce the demand of goods and services that are not necessary, and when demand reduces, then prices are also going to reduce, going forward. How does the increased Central Bank rate affect someone who was looking to, for example, secure a mortgage loan for their first home? The good thing about this Central Bank decision is that it’s a short term decision which is setting the ground for the long-term perspective. But when it comes to lending it doesn’t affect too much the long-term lending because long-term lending is based on how they [lenders] know the economy will perform for a long period. If, for example, they know that inflation is going to stay for 10 years, then it is going to affect that person who is going to build a first house. But if they know inflation is going to stay for only one year or only for two coming quarters, and they know that the Central Bank is taking action, that is a good message for both the borrower and the banks that are lending. The Central Bank is not seated idle but is following and setting a good ground for a sustainable economic growth and a stable inflationary environment. In that case, if the banks set an interest rate for a long period they know that inflation is not going to remain in double digit. They know the Central Bank is doing something. In that case, because the loan for the first house is not for one year, the rate that they are going to set is a rate for 10 years. Then one year or two quarters are not going to affect too much. But for a consumption loan, that’s going to be affected too much compared to an investment loan because when money is becoming expensive the orientation of funds is now going into sectors or activities that are more beneficial to the borrower and where the lender is sure to recover the money. In that case, for the short term, they know that if it’s a consumption loan for three months, they know that for that period the inflation is high or for the coming six months inflation is high and then the interest rate will be high. Then, what is your parting message to the aspiring first time home owner? I encourage them to, when they negotiate with the lender, to be aware that inflation is going to come down next year. And if it’s going to decelerate next year, this means that the interest rate they set should not be based on the inflation they see today. It should be based on the average inflation in the coming 10 years, which is expected to be around 5 per cent. Another thing that can comfort them is that the Central Bank is doing its best and is taking necessary decisions to bring inflation back to the objective of the Central Bank. The objective of the Central Bank is 5 percent. Five percent is the normal inflation rate in line with the macroeconomic fundamentals of Rwanda. With an inflation that is around 5 percent, the economy can grow easily, up to 9 per cent without destabilizing prices, which means that that growth can be sustained for a long period. But if inflation is very high for a short period, one would say that it has no effect on economic growth but if it persists investors are going to be discouraged, the purchasing power of the consumer is going to reduce, and in that case, the economy will not grow sustainably as before. That’s the reason why we aim to bring inflation back to its normal path of the ideal level of 5 per cent.
