5 minute read
Global Monetary Policy Normalisation
The majority of economic discussions this year have been focused on inflation and monetary policy. For good reason. Inflation rates around the world, and more prominently in the western world, are soaring, reaching levels last seen in the 1980s.
There are a multitude of reasons for this. At the onset of the pandemic central banks around the world lowered interest rates to historically low levels to aid with the economic recovery. This, coupled with record amounts of stimulus in the form of free money distributed to consumers, resulted in the release of pent-up demand as harsh lockdown restrictions were lifted. Global supply chains were unable to keep up with the sudden increased demand as numerous factors converged to slow the movement of goods from one point to another, increasing the cost of logistics, and by extension the products demanded. The conflict between Russia and Ukraine, which is currently pushing up commodity prices such as oil, is certainly not helping in this regard.
Central banks typically resort to monetary policy tools to tame rising inflation rates by means of controlling the money supply and interest rates. They are, however, cautious of raising rates too aggressively at the moment as they are still unsure of the trajectory of inflation and would not want to disrupt an equally uncertain economic recovery. Hence we have seen little action from the US Federal Reserve and the European Central Bank thus far.
Locally, the Bank of Namibia’s (BoN) Monetary Policy Committee (MPC) in February raised rates for the first time in six years, following the South African Reserve Bank’s (SARB) decision to do so the previous month. As a member of the Common Monetary Area, Namibia has ceded its right of having an independent monetary system, and thus the BoN will have to follow any interest rate decisions made by the SARB, which is currently expected to raise rates an additional three to five times this year.
Low interest rates stimulate economic activity, with consumers more willing to borrow money to make large purchases, such as houses or cars, and making it cheaper for corporates to finance capital projects to expand operations. However, while Namibian households and businesses did benefit from historically low interest rates the last couple of years in the form of relatively cheap debt, the low rates did not spur credit uptake. In 2021, for example, private sector credit extension rose by a mere 1.0% year-on-year while interest rates were at historical lows. Namibian consumers were already heavily indebted prior to the pandemic while corporates opted to de-lever their balance sheets in the light of a subdued economic outlook, reducing the appetite of both groups for additional debt. Thus, while rising interest rates are not ideal in Namibia’s current economic climate, it is unlikely to have a significant negative impact on already low credit demand.
Rising interest rates should, however, have a more detrimental impact on asset prices. The ultra-low global interest rate environment of the last decade or so has inflated asset prices. Stocks, bonds, and real estate are trading at higher valuations than they would otherwise support. This is because debt funding has become extraordinarily ‘cheap’, which pushes up the profitability of firms, making them more valuable. With many countries now systematically reducing restrictions to curb the spread of the virus and treating it as an epidemic, the economic growth outlook for most countries is improving and with it there is less need to stimulate economic activity through relatively lower borrowing costs.
So-called ‘growth stock’ companies, which are generally reliant on low interest rates to continue expanding their operations, are expected to feel the brunt of the impact of higher interest rates due to their cost of capital increasing, coupled with lower consumer demand as they will have less discretionary spending money. By contrast, ‘value stocks’ which trade at lower prices relative to their fundamentals, typically perform better during rising interest rate environments, as they tend to be more mature companies with the ability to pass on inflationary increases to their customers and are thus able to protect their profit margins better than growth companies.
We anticipate that monetary policy normalisation will remain a key theme for the rest of the year due to its wideranging impact on the broader economy and asset prices. Despite being a small economy, Namibia is joined at the hip to the South African economy and will therefore also feel the impact of global monetary policy normalisation.
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Danie van Wyk – Head: Research
