Higher interest rates raise fears

The increase by the National Bank of Rwanda of the Key Repo Rate from7 per cent to 7.5 per cent last Friday, could spark off a new wave of interestrate hikes by commercial banks for both new and existing loans, business leaders have warned.The key Repo rate is the rate at which the central bank lends to commercial banks. The higher the rate, the more it is likely to reduce liquidity in the banking system.Speaking to The New Times, yesterday, the Director of Advocacy in Private Sector Federation (PSF), Gerald Mukubu, said the increase was a surprise, pointing out that PSF was not consulted as is usually the case.“It is expected that the commercial banks will reiterate by increasing their lending rates and this could constrain private sector growth and investment. It impact negatively on investment, production and businesses returns on investments at macro-economic level,” Mukubu said.The central bank said the move would help contain inflation which stands at 8.18 recorded in the first quota of 2012, from 7.81 in January this year.East African countries have been battered by volatile economic environment with Kenya and Uganda facing the most challenges.The two nations’ currencies have heavily depreciated against the dollar due to reducing dollar inflows.Rwanda’s inflation is still the lowest in the region compared to other East African countries, including Uganda, at 20.3 per cent; Kenya, at 13 per cent; and Burundi, at 24 per cent.But business leaders say increase in central bank lending rates could increase the cost of borrowing, dampening demand and production, and exposing existing and potential borrowers whose loan repayment could soar.Mukubu said there were various tools that the central bank could use to tackle inflation without necessarily raising the lending rates.Analysts warn that if commercial banks respond by increasing their interest rates on existing loans, it is likely to push more borrowers to default on their debt servicing.Also afraid are individual existing borrowers who could see their periodical repayment rise in case the commercial banks hiked their rates, yet they need more francs to buy the same basket of goods amid stagnant income.“If commercial banks respond by increasing their interest rates we may end up toiling for the banks,” Joseph Manzi, a civil servant told this newspaper.Hatari Sekoko, Executive Director, Doyelcy Ltd, told The New Times that as traders they “would have no alternative but to go by the dictates of the market forces.”Rwanda’s economy is projected to grow by 7.7 per cent this year, lower than last year where it grew by 8.6 per cent.The central bank insists the bank is right to tackle inflation by increasing the cost of borrowing. “We are taking measures, giving ourselves room so that if anything comes we’ll be better prepared,” Central Bank Governor, Amb. Claver Gatete told reporters last Friday.Understandably, the bank loans are prime-based whereby rise or fall is based on market conditions.How the central bank will protect existing borrowers remains unclear.Customers may need to negotiate with their banks to borrow on a fixed rate so that the rate is not adjusted irrespective of the market conditions.Experts say tight liquidity conditions in the domestic money market leaves commercial bank excess reserves in negatives, with most commercial banks remaining with reserves only enough to meet their day to day operations.On whether this could weaken commercial banks’ ability to lend to the private sector, the Managing Director, Kenya Commercial Bank (KCB) Rwanda, Maurice K. Toroitich suggested the central bank increase was moderate.But even in the case of high lending rates to commercial banks, what banks normally do is to increase the cost of borrowing because banks are market intermediaries which pass on the liquidity cost from the lender to the borrower.Toroitich explained that the ongoing risks associated with the debt crisis in Europe and related fears that major European economies are not yet out of the risk of debt default, high regional inflation that’s riding on the back of high commodity and fuel prices – coupled with a poor domestic crop season – mean that Rwanda needed to maintain a tight monetary policy to suppress inflation.Food crop for country’s season A did not perform well, at +1.3 per cent, compared to +5.4 per cent last year, and far below from an average of +10.1 per cent in the last five years.“Although the increase in the policy rate is modest, the indication is that market interest rates are likely to be edging upwards if the inflationary pressures persist. In a free market economy like Rwanda, bank customers must be prepared to pay more for loans during such times in the same way they would benefit from a lower cost of loans in reducing inflation or interest situation,” Toroitich said.“It’s all a matter of balance to maintain macro-economic stability, both in the short and in the long run.”