The Monetary Policy Committee – Lower Interest Rates

The Key Repo Rate (KRR) of the Bank of Mauritius (BoM) was reduced by one quarter per cent to 4.4% at the last Monetary Policy Committee (MPC) meeting of Monday 9th November. A reduction in the interest rate of the BoM signals to market participants that they can equally reduce the interest rate they are charging on loans to borrowers and the rate they are paying to depositors.

Commercial banks had already successively reduced over the past years their interest to both borrowers and depositors, in response to past MPC decisions. As a result, the current interest they pay on savings deposits has dropped to around 3%. The question on most people’s mind is therefore whether the BoM has given to commercial banks a new signal to pay an even lower interest rate to depositors.

The BoM has mentioned in its press release following the MPC’s decision that lowering of the interest rate was intended to support domestic economic activity in a context in which domestic private investment was not picking up. There is also a reference in it to prevailing large amounts of surplus liquidity that had to be mopped up from the market.

Putting together domestic investment not picking up along with available large amounts of liquidity on the market and the last MPC’s decision to bring down the interest rate, implies that the MPC considers that lower interest rates would help domestic investment pick up.

This hypothesis is simply not borne out by the facts. Past MPCs have put successive downward pressures on the domestic interest rate since quite long. Domestic private investment has hardly edged up despite the consequently falling level of the interest rate. It means that the pace of domestic investment and the level of the interest rate in Mauritius are nor currently correlated. There is no causal relationship between the two because had this been the case, previous reductions in the Key Repo Rate would have triggered higher levels of domestic investment by now.

This has not happened, which means there must be reasons other than the interest rate factor which are keeping domestic investment down.

If the level of the interest rate is irrelevant, policy makers should have acted on those other reasons and not on the interest rate factor if the objective was to improve domestic private investment as a way of growing up the economy.

In the circumstances, what will the current reduction in the interest rate following the MPC’s decision achieve? Various sectors of the private sector activity (such as Construction, Tourism, Financial Sector, etc.) have borrowed huge amounts from financial institutions. They are saddled with servicing the interest cost of such borrowings. Were borrowing interest rates of these sectors to come down as a result of the MPC decision, they will get a windfall gain in terms of a lower debt servicing compared to what it was before. But that benefit will most probably be pocketed away without them raising the level of domestic private investment. That’s because a higher level of domestic investment depends on other than the interest rate factor.

What are these other factors? First, it is the optimism with which investors see prospects for economic growth in Mauritius. Second, even if they were optimistic that the economy will do well, a sector will undertake higher investment if it is itself headed for further growth. If there is little demand either at the domestic or international level for what it can produce, it will not have an incentive to invest more. It might even be having excess production capacity from its past investments, so it might have no incentive to invest on top of that. The latter is the situation many enterprises are caught up in at the moment.

The un-improving domestic investment is due not to the interest rate factor, but rather to non-monetary factors. So, it doesn’t help if the monetary factor alone is adjusted. All that is achieved is ‘windfall gains’ to those who are already heavily borrowed up by way of paying lower interest on their existing debts than before due to administrative fiat, notably the MPC’s decision to reduce the interest rate. On the other hand, savers will face up to ‘windfall losses’ if the interest they earn gets reduced due to the MPC’s latest decision.

In other words, savers’ interest earning will get reduced and that amount will be shifted away by financial institutions in favour of the past borrowers – corporate borrowers principally — who will have even lower amounts of interest to pay on their debts, without having to show higher investment or levels of employment in return. Benefits can be staggering, despite the quarter per cent decline of the KRR at the last MPC. A quarter per cent fall in the interest rate will shift Rs 150 million in a year in favour of a corporate borrowing of Rs 60 billion by a single sector of activity such as Construction. It is by this process that decisions of public institutions have helped feed into a culture of greed by corporate borrowers in most capitalist countries, resulting in ever increasing income and wealth disparities between the haves and the have-nots.

One is reminded in this context of the highly socialist previous Governor of the BoM, Mr R Bheenick, who was said to have fought epic battles in the BoM’s MPC in his attempt to avert socially unproductive interest rate reductions which used to be justified mostly by reference to the situation which prevailed in the richer countries of the world which had almost flattened down the level of their domestic interest rates without getting their economies off the ground. Depreciation of the rupee since the beginning of this year has already hit consumers’ pockets no matter what inflation statistics state. It remained for interest rate paid on savings to also go down. This has now been done after a semblance of pause at the previous MPC which had decided to keep the KRR steady at 4.65%.

  • Published in print edition on 13 November 2015

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