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IMF interest rate fears dampened

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Hubert Edwards

• Analysts: ‘No need’ for Bahamas to hike borrowing costs

• Fund suggests rises ‘as needed’ to protect US dollar peg

• But prospects for near-term consumer credit boom dim

By NEIL HARTNELL

Tribune Business Editor

nhartnell@tribunemedia.net

Bahamian financial analysts yesterday dampened fears of near-term interest rate hikes after the International Monetary Fund (IMF) suggested such increases may be necessary to protect the US dollar exchange rate peg.

Hubert Edwards, head of the Organisation for Responsible Government’s (ORG) economic development committee, told Tribune Business he “didn’t really see the need for increasing interest rates” unless there was a sudden surge in consumer credit and import purchases that diluted the foreign currency reserves beyond acceptable levels.

Hinting that a credit-fuelled explosion in consumer demand was highly unlikely, given the challenges banks are having in locating qualified borrowers, he added that the $2.448bn worth of surplus liquidity in the commercial banking system will also act to maintain Bahamian interest rates at their current levels.

Mr Edwards was backed by Gowon Bowe, Fidelity Bank (Bahamas) chief executive, who also told this newspaper that he “certainly doesn’t see” any increase in the discount rate, and Bahamian Prime, within the next 18 months. He added that the nation has “quite a way to go before seeing any interest rate movement of consequence”.

Both men spoke out after the IMF, in a statement on the completion of its annual Article IV consultation with The Bahamas, raised the spectre that the Central Bank may have to increase Bahamian dollar interest rates as necessary to support the external reserves and maintain the one:one exchange rate peg with the US dollar.

“The exchange rate peg to the US dollar has served as an anchor of macroeconomic stability,” the Fund said. “It is recommended that the Central Bank allows interest rates to rise, as needed by market conditions, to support the currency peg without having to resort to a drawdown of international reserves. If the market environment were to deteriorate markedly, consideration may need to be given to a temporary tightening of capital flow management measures.”

John Rolle, the Central Bank’s governor, did not respond to Tribune Business phone messages and e-mails seeking comment before press time last night. However, the mere mention or suggestion of an interest rate increase is likely to have provoked consternation among some given that it raises the possibility that borrowing/debt servicing costs will rise and impose a further burden on struggling businesses and consumers still grappling with COVID-19 and inflation.

Any interest rate increase, though, would go against the “accommodative stance” that the Central Bank has adopted for some time in its monetary policies, and which was reiterated as recently as January 2022. “Based on the prevailing outlook, the Central Bank will retain its accommodative stance for private sector credit and continue to pursue policies that ensure a favorable outturn for external reserves, and mitigate financial sector disruptions,” it said in its latest report.

“In addition, the bank will continue to assess developments within the foreign exchange market and, if necessary, adopt appropriate measures to support a positive outcome for foreign reserves,” Mr Rolle has also said repeatedly that the Central Bank has the necessary tools to manage any unexpected dilution of the foreign currency reserves, and protect the exchange rate peg, if the situation demands. A small, manageable decline in the reserves is expected this year.

Outside observers also branded the possibility of a Bahamian interest rate increase highly unlikely. Mr Edwards said: “At this stage, unless there’s a huge concern about inflation and the possibility we are heading in that direction, I don’t really see the need for increasing interest rates.

“It’s kind of difficult to see how rates are going to increase when you think about the level of liquidity in the system. We have a lot of liquidity and the banks are well-capitalised. There was obviously a reduction in the demand for lending. Banks will generally see this as an opportunity to get excess liquidity into productive loans. I don’t really see where the Central Bank will want to increase interest rates at this time.”

This is because any interest rate rise, and hikes in the cost of capital and borrowing, would threaten to choke-off The Bahamas’ still-fragile post-COVID recovery. Besides deterring new credit-financed investment and job creation, it would also raise debt servicing costs for existing business and consumer borrowers, potentially helping to push them back into financial hardship once again.

The Central Bank last acted on interest rates in December 2016, when it slashed the discount rate by 50 basis points to the present 4 percent. Bahamian prime, which the commercial banks and other lenders use as the benchmark for pricing their loans, also dropped by the same 0.5 percentage points to the current 4.25 percent. Interest rates in The Bahamas have only been adjusted twice in the last 11 years, with cuts coming in 2011 and 2016.

Mr Bowe yesterday said this affirmed how Bahamian monetary policy is not employed as a stimulative tool to expand the economy, as in other nations, but rather its overriding objective is to preserve the one:one fixed exchange rate that this country’s non-convertible currency has with the US dollar.

Describing the IMF’s “theory” as accurate, the Fidelity chief added: “In practice, our monetary policy is to protect the peg. Their narrative changed to say interest rates need to be used to protect the peg. That happens when Bahamian dollar credit creation exceeds US dollar credit creation.”

Despite the recent US interest rate increase to combat soaring inflation, Mr Bowe said the US “prime rate” would have to rise by another 100-150 basis points - taking it from 3.5 percent to between 4-4.5 percent - for there to be any likelihood that will happen. And the US Federal Reserve, due to the economic fall-out from Russia’s invasion of Ukraine, was likely to adopt a more cautious, measured approach to any rate hikes.

“The reality is that no foreigner will borrow in Bahamian dollars, convert to US dollars and invest in the US. The room for interest rate arbitrage is very limited because of exchange controls,” Mr Bowe said. “The economic theory behind it is accurate, but in practical terms the US rates have to go so high to make it attractive to get Bahamian dollars. I don’t see it any time soon.”

As for the prospect of any Bahamian interest rate jump, Mr Bowe added: “I don’t see that. You can’t really predict out more than 18 months, but I certainly don’t see any in The Bahamas in the next 18 months. I think the IMF statement is fair and legitimate on [capital flow management], but we have quite a way to go before we see any interest movement of any consequence.”

He explained that the Central Bank had traditionally raised interest rates to “stifle” Bahamian dollar credit growth that was producing a consumer import boom, and running down the external reserves to pay for it. With borrower quality making any “skyrocketing” in credit growth unlikely, Mr Bowe said: “The consumer quality means we will not see a large expansion in consumer credit.”

Comments

tribanon 10 months, 3 weeks ago

The rising political heat angry Americans are giving their elected representatives about the soaring rate of inflation will determine how high and how fast the U.S. Federal Reserve ('the Fed') must increase the benchmark U.S. interest rate.

The Biden administration and the Fed will try use Russia's invasion of the Ukraine as an excuse for their need to significantly increase U.S. interest rates in an effort to combat the out-of-control inflation caused by more than a decade of printing money willy-nilly to keep U.S. debt service costs low and financial asset prices high.

The savings of risk averse aged baby boomers in the U.S. have been raped, pillaged and plundered by the U.S. government keeping interest rates artificially low for well over a decade now in one of the greatest transfers of wealth through hidden taxes to help contain the effects of unfunded social security, medicare and other entitlement costs. The distortionary effects of that dastardly deed are now coming home to roost in a most vicious way, i.e., out-of-control inflation.

You only have to look at what has been happening to the yield curve for U.S. debt instruments to understand that the pied piper must now be paid to avoid an entrenched hyper-inflationary scenario and it ain't gonna be pretty paying him, especially for small nations like The Bahamas.

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