John Weeks, Professorial Research Associate, Center for Development Policy Research (CEPR), SOAS, argues that the IMF is mistaken in emphasising the reliance on monetary policies in sub-Saharan Africa because few countries have viable domestic markets for government bonds or commercial banking sectors interested in lending for private-sector investment. As a result, central banks often have to offer high rates of interest on government bonds to induce banks to buy them. Thus, a significant share of the public budget is diverted into debt servicing that ends up fattening banking profits.
In most sub-Saharan countries the demand by commercial banks for bonds does not readily respond to changes in the interest rate. One reason is that there is little competitiveness in domestic bond markets and another is that the bonds of African governments have extremely low credit ratings from Standard and Poor’s or Moody’s—if they are rated at all.
The main impact of the central bank’s raising of the bond interest rate will be to induce commercial banks to replace loans to the private sector with government bonds because the relative return from the former has fallen. This is a perverse result because when bonds increase the assets of commercial banks, they should expand their creation of credit. But because of the high yields received by banks on government securities, it is profitable for them to hold excess reserves instead of lending.
This process is fundamentally different from the so-called ‘crowding out’ of private investment, about which the IMF repeatedly warns national policymakers. But the ultimate effect is the same. ‘Crowding out’ allegedly occurs when government borrowing to cover public expenditures competes with private borrowing. The dynamic that we are describing is different because the increase in the central bank rate does not originate from a need to cover public expenditure, but from the false expectation that the higher rate would appreciate the exchange rate and reduce inflationary pressure.
The conclusion is pretty surprising (at least if we consider standard economic theories): "The reality in sub-Saharan Africa is that, with very few exceptions, monetary policy has no meaningful impact on inflation or the real exchange rate."
