Africa: Are interest rate hikes enough to limit economic shocks?

By Kanika Saigal
Posted on Tuesday, 27 September 2022 18:32, updated on Wednesday, 28 September 2022 10:49

Nigeria's Central Bank headquarters in Abuja, November 22, 2020. REUTERS/Afolabi Sotunde

African central banks are poised to raise interest rates, following similar moves in economies around the world. Analysts believe this is unlikely to either curb inflation, or encourage fresh portfolio flows.

After Nigeria’s Central Bank raised the monetary policy rates to 15.5% on Tuesday, Egypt and South Africa could follow suit within the next week, as central banks tighten monetary policy to attract portfolio flows to the region and stem spiralling inflation.

Nigeria’s Monetary Policy Committee (MPC) met early this week to discuss whether the Monetary Policy Rate (MPR) will rise above 14% – a level unseen since official records began in 2006. This was the third hike that the committee has made this year following two others in May and July, which saw rates increase from 11.5% to 14%.

Egypt may raise its MPR between 50 and 100 bps from the current 11.75%. Meanwhile, South Africa could increase the repurchase rate to 6.25%, from 5.5% currently.

Unlikely to attract fresh flows

However, while central banks use interest rates as a key monetary transmission mechanism – to curb inflation for example – this is less effective in emerging and frontier economies because transition mechanisms are not as developed. As a result, there is often a lag between policy and market rates, says George Bodo, director, Callstreet Research and Analytics based in Nairobi.

“Broadly speaking, policy rate hikes in Africa reflect similar responses to those made in developed markets, but in Africa, they are also used to encourage portfolio flows to the continent to support economic growth, steady FX reserves and stabilise exchange rates,” he says.

Samir Gadio, head, Africa Strategy at Standard Chartered is not convinced that rate hikes will encourage capital flows to Africa, however, because capital flows are driven by global risk conditions. “As the Fed tightens monetary policy and as the dollar appreciates, it is unlikely that we will see additional flows to African markets even if they tighten monetary policy further,” he says.

“Central Bank policy in many African countries is less about maintaining capital flows and more about avoiding further shocks to the system.”

Impact on economic growth

The rising cost of global energy prices, due in large part to Russia’s invasion of the Ukraine, has put significant pressure on foreign exchange (FX) reserves in Africa and has led to a cost of living crisis across the board.

At the same time, climate change and conflict in major agricultural regions – in places such as Nigeria, Benin, and the Horn – has limited reliable access to food, pushing prices and inflation higher.

FX liberalisation to allow capital flows out of the country is not a policy priority for the government at the moment because the need for FX for imports is just too great

As well as hiking interest rates, some African countries have put in place restrictive FX policies to shore up reserves and cover imports. However, given the lack of cash available, public investment may suffer, further stifling economic growth.

“Foreign investors have not been able to get money out of Nigeria and we have seen FDI to the country dry up,” says Gloria Fadipe, head of research CSL Stockbrokers Limited, based in Lagos.

“At the same time, the country is only just emerging from a recession, population growth is around 3%, consumer power is low, and inflation is 22.5%. Prices have gone up astronomically and manufacturers cannot sell products.

“In any case, FX liberalisation to allow capital flows out of the country is not a policy priority for the government at the moment because the need for FX for imports is just too great,” she says.

Flight to safety

Moreover, within the current risk-off environment, investors will flock to safer government bonds, which can lead to the crowding out of the private sector, which is unable to access affordable credit, explains Damilola Olupona, analyst, Chapel Hill Denham based in Lagos.

“By and large, investment into Africa is usually short-term, so interest rate hikes globally may encourage an exodus of capital from Africa to more developed markets in any case,” says Olupona.

According to data compiled by the World Bank, while continental growth rebounded in 2021 to 4% – from a contraction of 2% in 2020 – growth is expected to drop to around 3.6% in 2022 amid global political and economic uncertainty.

In response to the worsening economic situation, a number of African countries have entered into new deals with the IMF. Kenya, Zambia and Benin have agreed Extended Finance Facilities (EFF) this year, Egypt hopes to finalise a package with the development finance institution in the next few months, and the IMF are currently in Ghana to discuss policy reform that could inform a new lending arrangement.

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