Africa's interest rate debacle

Several African countries are dealing with a crisis of unparalleled proportions. Foremost among these economic challenges is the serious devaluation of their national currencies, coupled with rising inflation.

All these countries now have one thing in common: exorbitant interest rates on deposits. This affects every aspect of life in Africa - from buying a house to consumer choice. (Creative Commons)

In response, select countries are now guaranteeing annual interest bearing deposits of up to 30 percent. Ask the question what justifies such high interest rates, and the answer you get is it’s necessary to combat inflation. 

But, this would only be true only if the inflation you’re combating is too much money chasing too few goods. In my mind, this doesn’t pass the plausibility test. 

Too much money would mean the money supply (M1) has grown to an inordinate level, and high interest rates are required to suck up the excess. 

But, the countries now instituting these very high interest rates are also among the poorest in the world. In these countries, 60 percent of the population lives on under $3 a day. So, if the money supply is excessive, this isn’t induced by consumer spending. The culprit is government spending. 

Inflation is likely being fueled by excessive government spending, not consumer spending. Every one of these African countries is import dependent for both foodstuffs and intermediate inputs. If your national currency has devalued from 50 - 120 percent in the last year, which is the commonality they all have, then consumer spending has already taken a hard hit. Import inflation has already put a serious damper on consumer spending. Consumer spending isn’t spurring inflation, it’s the victim of it. 

To offset government spending, the IMF is now telling every one of these African nations to shed state enterprises. But, this is also how these countries are generating much needed employment. Either way, decreasing government spending has nothing to do with interest rate bearing deposits close to 30 percent. 

These high interest rates are clearly detrimental to private sector development. Why would anyone start a new business when you can put your money into a savings account that generates 30 percent interest? Why wouldn’t the rational investor just shudder his business, big or small, and put his money in a bank guaranteeing a 30 percent return? Why would anyone risk their hard earned cash in the stock exchange? Why would anyone borrow from banks that now charge very high interest rates on loans to make up what they have to pay on deposits?

All these countries now have one thing in common resulting from these exorbitant interest rates on deposits. Domestic investment has fallen off the cliff, and levels of consumer borrowing in select sectors have dropped to concerning levels. I fear the way these countries have tried to combat inflation is a misdiagnosis of their economic reality. The time for a rethink is now.