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February 20, 2019

Rate cap poses a challenge to MPC decision

The Monetary Policy Committee retained the Central Bank Rate at 10 per cent in its meeting held last week on November 28. This is the second meeting since the capping of interest rates that took effect on September 14. In arriving at the decision, the committee cited mild inflationary pressures. Inflation is also expected to remain within the government short-term target range of between 2.5 and 7.5 per cent. It also quoted the current uncertainties in the local and global economy.

Notably, the committee is of the view that the impact of the cap on interest rates on monetary policy and the overall economy is inconclusive. This is because available data is not adequate to support credible analysis. This continues to be a wait-and-see situation. In its previous meeting, barely one week after the introduction of the interest rates cap, the committee lowered the CBR rate from 10.5 to 10 per cent. This came as a shocker to the market that was yet to come to terms with a controlled credit market. At the time, the decision of the committee aimed at increasing credit to the private sector. It also considered demand pressure on inflation as moderate and inflation was expected to decline.

The MPC has been taking an more central role in the financial services sector and the economy than ever. Before the rate cap, the change in both the direction and magnitude of the CBR signalled the monetary policy stance. The decision would then affect economic activity and inflation through several channels, which make up the transmission mechanism of the monetary policy. After the rate cap, the CBR plays a more direct role of setting the maximum lending rate and the minimum deposit rate. Credit is now priced at a maximum of 4.0 per cent above the CBR and deposit at a minimum of 70 per cent. In a way, this makes the transmission mechanism less effective because it has to work within the confines of the cap. In fact, the Central Bank governor is quoted as saying that the interest capping would complicate monetary policy.

To the financial sector, it limits the price of risk which could mean high risk customers may be denied credit. In the recent meeting, the MPC noted that credit to the private sector has stabilised, following a decline it its previous meeting. It also revealed that liquidity in the market had increased to 43.6 from 41.9 per cent. This means the banks are holding more cash and near cash assets. However, it is too early to be conclusive this is a sign of credit restriction in response to the interest rate cap. But it is certain that structural changes are expected as the financial industry adjusts to the law.

The writer is a financial and risk consultant at First Trident Capital

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