Ghana’s interest rates killing businesses
The modern economy is controlled by the government of the day. Since money lost its cherished status as being backed by gold in the early 1970s, it has now become what we call fiat money. In other words, it is the government of a nation that issues and controls the country's currency. Individuals have no real money, since real money is silver or gold or any other durable commodity.
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The government has as part of its economic policy objectives to achieve steady economic growth, a low and stable rate of inflation and a low rate of unemployment. These objectives can only be achieved if it is the government that is in charge of the country's money. The government then cedes power to the nation's central bank to control the currency.
The central bank then performs its duty using certain tools, with the main one being the interest rate. Thus, the central bank sets an interest rate at which it will lend to commercial banks and these banks add some percentage to the central bank rate, taking account of risk, inflation, cost of service provision and desired profit levels.
Therefore, the interest rate set by the central bank is a major determinant of prevailing rates of interest in an economy. The central bank increases or decreases the interest rate depending on whether it wants to increase or decrease the money supply. Thus, higher interest rates will be associated with a desire to decrease the money supply and thereby dampen economic activity, to lower the rate of inflation.
Lower interest rates, on the other hand, are designed to achieve increases in the money supply, which will provoke economic activity and bring about economic growth. Hence, Ghana's interest rate of 26 per cent, we are led to believe, is designed to curb the country's rate of inflation, currently in the region of 18.9 per cent.
In Ghana, our central bank is the Bank of Ghana which sets this interest rate, known as the policy rate. In our opinion, the current rate is comparatively too high, and ,therefore, has in it the seeds of economic fragility.
The consequences of high interest rates
High interest rates are desirable for an extremely overheated economy to prevent the domestic currency from suffering large loses in value. In the absence of that, very high interest rates can have a deleterious effect on an economy.
It is clear that at such a high rate of interest, Ghana is not benefiting from the gains derived from low interest rates already outlined above.
Thus, we are suffering from depressed economic activity because of reduced money supply, and the prices of goods and services have risen because of increased costs of production.
This situation has a ripple effect. First, it reduces consumers' standard of living because of inability to afford certain goods and services. Consumers may also suffer from reduced disposable incomes if they have taken loans; because a higher proportion of their income will go towards interest payments.
Second, firms face reduced demand and cannot expand production, and may even reduce their output. Third, firms will not increase hiring, and may even decide to reduce employment. Fourth, when this happens, unemployment will rise, leading to a fall in aggregate demand, and thereby a reduction in the rate of economic growth.
Additionally, the very high interest rate has not succeeded in bringing down inflation, implying that the Bank of Ghana is fighting the inflation in the country with the wrong tool; that is, continuous increases in the policy rate.
At an interest rate of 26 per cent, data from Trading Economics indicate that Ghana's current year-on-year GDP growth rate is 4.9 per cent, with a total GDP of US$39bn, and an inflation rate of 18.9 per cent. At the same time, a country such as Tanzania, with a lower interest rate of 12 per cent records a current year-on-year GDP growth of 7.1 per cent, with a total GDP of US$48bn, and an inflation rate of 5.2 per cent.
It is easy to see how Tanzania has outclassed Ghana, when one considers these fundamental economic indicators; and thereby, the potential benefits inherent in a low interest rate environment. It is reasonable to assume, however, that other factors may have influenced the differences observed here, and one may contend such a comparison is too simplistic.
Nevertheless, as Table 1 indicates, Tanzania still outperforms Ghana when we consider data for the past three years from 2013-2015. The table shows an average interest rate of 17.3 per cent for Ghana and 12 per cent for Tanzania.
Over the same period, the respective mean GDP growth has been 5.1 per cent and 7.1 per cent for Ghana and Tanzania, whilst the average inflation rates are reported as 14.7 per cent and 6.5 per cent respectively. Tanzania also records a relatively higher level of mean capital formation (gross investment) as a percentage of GDP of 31.2 per cent, compared to Ghana's 28.1 per cent (2012-2014). Thus, there is a reward to be gained in maintaining a low interest rate economy. It is also important to note that the other consequence of a high interest rate environment is increased financialisation of the economy.
The effect of financialisation
Financialisation of the economy could be defined in many ways. It may be referred to as "the increasing dominance of the finance industry in the sum total of economic activity" or the "growing scale and profitability of the finance sector at the expense of the rest of the economy ". It may also be defined as a "pattern of accumulation in which profit making occurs increasingly through financial channels rather than through trade and commodity production". What this essentially means is that financialisation diverts relatively more funds to the finance sector of the economy at the expense of the real sector. Thus, when interest rates are very high, it makes sense for surplus units to invest in financial assets rather than spend their time and energy on investing in the production of real goods and services, which has the potential to create jobs.
Therefore, the consequence of financialisation is that people invest to get high interest rates, so they do not invest in an economic activity that produces goods and services. Households with debt have to use a higher proportion of their income to service their interest payments, leading to reduced spending power. Companies paying relatively high interest rates suffer from reduced profits, and therefore cannot invest in the production of more goods and services.
The combined effect of these is that inequality increases, unemployment rises because jobs are not created, and economic growth slows down. Reduced investment in physical assets may explain why Ghana has a lower three-year average of capital formation as a percentage of GDP (28.1%) compared to Tanzania's 31.2 per cent as depicted in Table 1. The annual data actually shows that Ghana's figure dropped from 50.3 per cent of GDP in 2012 to 2.8 per cent of GDP in 2014. Financialisation is only concerned with making money from money and does not promote any appreciable increase in economic output. If Ghana must rise from our economic malaise, we must reverse this trend of rising interest rates, and begin to make money from the production of goods and services.
The way forward
What must, therefore, be the way forward for our monetary policymaker, the Bank of Ghana? First, they should recognise that the current inflation we have the country for which reason they have hiked interest rates is not caused by excessive increases in aggregated demand, but by increases in costs of production. If that is the case, then the sustained increases in interest rates will do nothing to lower the rate of inflation, and is therefore, not warranted. Second, they must come to understand that the rise in costs of production which is fuelling the inflation rate is as a resulting effect of the high interest rates faced by firms, the rise in energy fuel prices perpetrated by the government and to some extent the instability of the cedi.
Third, such an acknowledgement should then be followed by a gradual reduction in interest rates, to a level capable of reviving economic activity. Such a policy direction will reduce the burden on firms, expand the economy to create jobs for households, and thereby, improve standards of living. It will thus, place the country on its trend growth rate, and also has in it the seeds of curbing the growth in prices.
Notes: The data has been obtained from World Development Indicators (WDI). They show the three-year averages for the years indicated.
The writer is an economist and a lecturer in the Banking and Finance Department at the Central University, Accra.
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