GAB CEO highlights link between Balancing Interest Rates and Economic Stability

The Chief Executive of the Ghana Association of Bankers (GAB), John Awuah, has underscored the importance of interest rates and economic stability to nation building. He thus, explained the crucial link between interest rate adjustments and the overall economic stability.

Mr. Awuah further highlighted the importance of aligning interest rate movements with the prevailing economic conditions rather than resorting to coercive measures.

Mr. Awuah, therefore, cautioned against forcing down interest rates without supportive economic fundamentals, emphasizing that such actions could have adverse effects on the financial system. He noted instances where banks have swiftly adjusted their rates in response to improvements in key economic variables, suggesting a natural alignment between interest rates and economic performance.

The recent monetary policy actions, including a 100-basis points reduction in the policy rate by the Monetary Policy Committee, were discussed in the context of their impact on lending rates. Mr. Awuah acknowledged that banks historically adjust their lending rates in line with changes in key economic indicators, demonstrating a responsive approach to monetary policy changes. Despite fluctuations, he noted instances where financial institutions have adapted their rates, particularly for loans with variable terms.

The conversation also delved into the implications of persistently high-interest rates on Ghana’s commercial banks. Despite the average interest rate climbing to 30.19% by the end of 2023, Mr. Awuah dismissed the notion that banks profit significantly from elevated lending rates. Instead, he attributed higher interest rates to increased default risks, stressing the importance of maintaining a balanced approach to lending practices.

Understanding

In the realm of economics, few factors wield as much influence over the stability and trajectory of an economy as interest rates. The relationship between interest rates and economic stability multifaceted, and crucial for policymakers, businesses, and individuals alike to comprehend.

Central banks utilize interest rates as a primary tool to manage monetary policy and regulate economic activity. By adjusting interest rates, central banks seek to achieve various objectives, including controlling inflation, stimulating economic growth, and maintaining price stability. Lowering interest rates typically encourages borrowing and spending, thereby stimulating economic activity, while raising interest rates tends to curb inflation and excessive borrowing, albeit at the potential cost of slowing down economic growth.

Interest rates directly affect the cost of borrowing for businesses, consumers, and governments. When interest rates are low, borrowing becomes cheaper, incentivizing businesses to invest in expansion projects, consumers to purchase homes and durable goods, and governments to finance infrastructure development. Conversely, higher interest rates increase the cost of borrowing, which can deter investment and consumption, potentially leading to a slowdown in economic activity.

Interest rates also influence investment decisions and asset prices in financial markets. Lower interest rates generally lead to higher stock prices as investors seek higher returns in equities compared to fixed-income investments. Conversely, higher interest rates may prompt investors to reallocate their portfolios towards fixed-income securities, potentially leading to a decline in stock prices. Moreover, interest rates affect the valuation of bonds and other fixed-income assets inversely; when interest rates rise, bond prices fall, and vice versa.

Interest rates play a pivotal role in determining exchange rates and, by extension, a country’s trade balance. Higher interest rates tend to attract foreign capital inflows, leading to an appreciation of the domestic currency. Conversely, lower interest rates may discourage foreign investment, causing the domestic currency to depreciate. Changes in exchange rates influence export competitiveness and import costs, thereby impacting a country’s trade balance and overall economic performance.

Interest rates and inflation are closely intertwined, with central banks often adjusting interest rates in response to inflationary pressures. Higher interest rates can help curb inflation by reducing aggregate demand and cooling down an overheating economy. Conversely, lower interest rates may stimulate inflation by encouraging spending and investment. Central banks aim to strike a delicate balance between managing inflation expectations and supporting economic growth through interest rate adjustments.

Mr. Awuah’s insights shed light on the intricacies of Ghana’s banking sector, where interest rates remain closely intertwined with monetary policy decisions and economic indicators. His also remarks underscore the need for the understanding of the relationship between interest rates, economic fundamentals, and the stability of the financial system.