Murli Dhar

Interest Rate Structure: whither bound?

It is a sorry thing that debate of ideas is frequently whittled down in Mauritius to the defence of private turfs. At this rate, amalgamation of issues keeps frustrating the general interest for keeping alive lame ducks living on policy subsidies at public expense

Murli Dhar The Monetary Policy Committee (MPC) of the Bank of Mauritius (BoM) is due to hold its next meeting on June 13th when a decision will be taken on any change that need to be effected in the key Repo Rate of the BoM. As the level and direction taken by the Repo Rate of the BoM is normally assumed to influence to more or less the same degree deposit and lending rates of commercial banks and preferably also those of other non-bank financial institutions, it is normal that there should be an amount of speculation as to the direction and quantum of adjustment that the MPC may likely bring in the key Repo Rate.

In September 2010, taking into consideration the prevailing morose international economic conditions and the fact that domestic inflation appeared to be subdued, if not trending down, the MPC took the decision to lower the BoM’s Repo Rate by 100 basis points (bp). The scale of the decline came as a shock to the population. The private sector applauded it. On their part, banks did not appear to follow the lead given by the BoM to its full extent: banks’ weighted average lending rate went down by 67 bp from 9.9% in September to 9.23% in October 2010; their weighted deposit rate declined on its part by 65 bp from 4.5% to 3.85% in October 2010. However, banks continued to lower the remuneration paid to depositors; by March 2011, the weighted interest rate paid to depositors had come down to 3.67% from 3.85% in October 2010, thereby widening their margin between lending and deposit rates. 

At its meeting of 28 March 2011, the MPC decided by a majority vote to increase the BoM’s key Repo Rate by 50 bp as inflation had picked up considerably in the meantime and appeared to be on a sustaining trend despite the outlook for global economic recovery not being quite as rosy as one would have wished. Overall, banks did not fully follow the central bank’s lead as may be seen from the quasi static range of 3 to 4% in which they kept rates they were paying on savings deposits (a major component of total deposits at banks) locked up. They left their lending rates at more or less the same levels as in the past.

We are not quite sure as to how global inflation that has a direct repercussion on domestic inflation will conduct itself in the coming days. With oil price rising and forecast global food shortages due to adverse climatic factors in main producer countries the world over, imported inflation represents a serious concern at this stage. We cannot do much about it because we are excessively dependent on imports. External price increases are likely to seep through again as they have done in past months. An internal price pressure is simultaneously building up as local production is failing to match up to demand for certain key items of daily needs.

Moreover, despite some appreciation registered by the rupee recently, import prices have remained strong and pervasive, eating away into our purchasing power. One wonders how much more the extent of erosion of the purchasing power would have been had the rupee continued to follow its classic depreciation pattern of past years. In this sense, the BoM’s stewardship of the local currency has served a good purpose from the angle of protecting the general public against inflation.

However, there is more to it when inflation has already crept in. The public asks to be compensated for loss of purchasing power when this has happened. Wage and demand pressures build up in anticipation of further price increases in an inflationary environment. This can lead to rising local costs of production impacting negatively on the economy’s rate of growth and hence on the sustainable level of employment. The central bank cannot afford not to be alive to this risk, which is referred to as “second-round effects”, when taking its interest rate decision. It has to calm down expectations held to the effect that inflation is likely to proceed apace, the consequence of which is to create unnecessary demand pressures materialising in the form of locally generated inflation and acceleration of imports. This is the basis on which the hike of 50 bp was introduced in the BoM’s Repo Rate in March last, even though our not-so-bright economic outlook in the context of the observed slow pace of international economic growth was an equally important consideration. The balancing of competing demands on the policy makers’ choice in such contexts is usually very delicate. One’s gut feelings might go in the direction of giving a higher priority to economic growth by lowering interest rates than to the control of inflation by raising interest rates. Another decision-maker may be more inclined to the immediate problem of keeping inflation within bounds before it is too late.

Having gone towards the latter option at its meeting of March last, the MPC would be expected to affirm the signal it had sent to the market in March by keeping interest rates on the uptick. China and India, amongst others, have followed this track. No one in the world is saying that prices of commodities are tending to go down. No one is also saying that the world economy is poised for strong growth even though our traditional export sectors are doing reasonably well globally despite the rupee’s recent appreciation. There is therefore a good probability that interest rates would go up again if only to affirm the central bank’s determination to rein in inflation and be consistent with itself. This is the position the Governor of the BoM has publicly indicated as being reasonable.  

We believe that like every other member of the MPC, the Governor is entitled to his opinion on where the interest rate should go to. The Leader of the Opposition thinks differently. He has gone as far as to qualify the Governor as “dangerous and obsessed with increasing interest rates” for having taken the position he has. He has also stated that “the government insists on permitting the Governor to increase the interest rate once again” i.e., after the March 2011 decision of the MPC, which, it appears, Mr Bérenger has not been able to digest.

This kind of statement could have made sense when there was no MPC at the BoM but as from March 2007, there is one consisting of 8 members, everyone of whom has one vote with nobody having a casting vote in the decision to be taken. Furthermore, section 55(3) of the BoM Act 2004 states that “in the discharge of its functions, the Committee (i.e., MPC) shall not be subject to the direction or control of any other person or authority”. So, where does the government come into the picture? In England and other places where MPCs are in place, members do express their views on where they believe the interest rate should be, based on their individual assessment of the risks inherent in the economy. In giving out his opinion in this regard, the Governor of the BoM has done nothing extraordinary and hence he cannot be qualified as being “dangerous and obsessed”. His stand may not please the vested interests Mr Bérenger may be defending but he is fully entitled to hold an honest opinion on the issue without having to drag in the government by virtue of expressing his opinion openly.

It is a sorry thing that debate of ideas is frequently whittled down in Mauritius to the defence of private turfs. At this rate, amalgamation of issues keeps frustrating the general interest for keeping alive lame ducks living on policy subsidies at public expense. 

Murli Dhar

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