Why interest rates are high
Jun 07, 2009
EXECUTIVE TALK<br><br><b>By John Ssempebwa</b><br><br>THE high interest rates in Uganda continue to frustrate the private sector. But why are interest rates high? What is not correctly diagnosed can only be cured through miracles.
EXECUTIVE TALK
By John Ssempebwa
THE high interest rates in Uganda continue to frustrate the private sector. But why are interest rates high? What is not correctly diagnosed can only be cured through miracles.
Interest rates depend on four rates namely the Treasury Bill (TB) rate, inflation rate, risk rate and bank profit rates after taxes.
In Uganda, the TB rate is 11.7% (central bank, April 2009), that is the Government sells risk-free (sure-deal) TBs to banks at 11.7% to control inflation and to finance its activities. This is why banks can not lend at below 11.7%, for they would rather lend to the never-defaulting government at 11.7%.
Uganda’s headline inflation is 13.4%, meaning that if a bank has liquidity worth sh1m on January 1 2009, on January 1 2010, the same million will be worth sh866,000.
To retain its sh1m, the bank factors in inflation by charging 11.7 (TB rate) multiplied by 134/100 = 15.7%. This is why banks can not lend below 15%.
Thirdly, many banks have bad loans of up to 10%. Every time borrowers do not pay back in time or do not pay back at all, interest rates increase.
Business is risky. Many times the private sector fails to pay back. Banks must, therefore, charge above 15% x 110/100 = 16.9% as a minimum.
Finally, banks are not Father Christmas, they must earn profits after paying government taxes and meeting their operational costs.
Assume that banks earn a modest gross profit rate of 10%, interest rates can’t fall below 16.6% x 110/100 = 18.3%. Enter the effective tax man, who collects 30% corporate tax, meaning that interest rates can’t fall below 18.3%x130/100 (URA) = 23.8%.
Logically, this is the minimum rate at which banks can lend to the private sector in Uganda.
If the Government reduced its TB rate to 1%, interest rates would fall to 1% (TB rate) x 134/100 (inflation) x 110/100 (risk) x 110/100 (profit) x130/100 (URA) = 2.1%.
In the US, the TB rate is sometimes 0%. But this is not easy because the Government must control inflation, which if not controlled, will increase interest rates. The Government must also pay its suppliers, the private sector.
The best gift the Government can give Ugandans amidst the current global and national crunch is a significant expenditure cut. But this will not be easy and can frustrate the private sector. But if the Government allowed rural banks that lend to rural-based companies, agriculture, manufacturers, agro-processing, education, ICT, musicians, tourism, transport, for example, to pay 15% corporate tax, interest rates would fall to 1% (TB rate) x 134/100 (inflation) x 101/100 (risk) x 110/100 (profit) x 115/100 (URA) = 1.86%.
Banks would get motivated to spread further out to ‘tap into the rats’ menu (money kept in pots and holes)’ to increase credit available to the private sector.
The private sector has a role to play too! If only 1% defaulted on bank loans, banks would pride in “corporate private sector responsibility†to reduce interest rates to 1% (TB rate) x 134/100 (inflation) x 101/100 (risk) x 110/100 (profit) x 115/100 (URA) = 1.71%.
This is not easy because the private sector doesn’t intentionally default, but is hampered by many reasons, many of which are beyond its control.
Finally, every year, Ugandans lose sh120b to foreign reinsurers, money which would increase available credit. The Uganda Reinsurance company is long over-due.
Cutting interest rates is a huge national challenge. Both the Government and the private sector have a role to play. Probably, with more banks being established, the rates will fall due to competition.
The writer is the PSFU director for trade development
By John Ssempebwa
THE high interest rates in Uganda continue to frustrate the private sector. But why are interest rates high? What is not correctly diagnosed can only be cured through miracles.
Interest rates depend on four rates namely the Treasury Bill (TB) rate, inflation rate, risk rate and bank profit rates after taxes.
In Uganda, the TB rate is 11.7% (central bank, April 2009), that is the Government sells risk-free (sure-deal) TBs to banks at 11.7% to control inflation and to finance its activities. This is why banks can not lend at below 11.7%, for they would rather lend to the never-defaulting government at 11.7%.
Uganda’s headline inflation is 13.4%, meaning that if a bank has liquidity worth sh1m on January 1 2009, on January 1 2010, the same million will be worth sh866,000.
To retain its sh1m, the bank factors in inflation by charging 11.7 (TB rate) multiplied by 134/100 = 15.7%. This is why banks can not lend below 15%.
Thirdly, many banks have bad loans of up to 10%. Every time borrowers do not pay back in time or do not pay back at all, interest rates increase.
Business is risky. Many times the private sector fails to pay back. Banks must, therefore, charge above 15% x 110/100 = 16.9% as a minimum.
Finally, banks are not Father Christmas, they must earn profits after paying government taxes and meeting their operational costs.
Assume that banks earn a modest gross profit rate of 10%, interest rates can’t fall below 16.6% x 110/100 = 18.3%. Enter the effective tax man, who collects 30% corporate tax, meaning that interest rates can’t fall below 18.3%x130/100 (URA) = 23.8%.
Logically, this is the minimum rate at which banks can lend to the private sector in Uganda.
If the Government reduced its TB rate to 1%, interest rates would fall to 1% (TB rate) x 134/100 (inflation) x 110/100 (risk) x 110/100 (profit) x130/100 (URA) = 2.1%.
In the US, the TB rate is sometimes 0%. But this is not easy because the Government must control inflation, which if not controlled, will increase interest rates. The Government must also pay its suppliers, the private sector.
The best gift the Government can give Ugandans amidst the current global and national crunch is a significant expenditure cut. But this will not be easy and can frustrate the private sector. But if the Government allowed rural banks that lend to rural-based companies, agriculture, manufacturers, agro-processing, education, ICT, musicians, tourism, transport, for example, to pay 15% corporate tax, interest rates would fall to 1% (TB rate) x 134/100 (inflation) x 101/100 (risk) x 110/100 (profit) x 115/100 (URA) = 1.86%.
Banks would get motivated to spread further out to ‘tap into the rats’ menu (money kept in pots and holes)’ to increase credit available to the private sector.
The private sector has a role to play too! If only 1% defaulted on bank loans, banks would pride in “corporate private sector responsibility†to reduce interest rates to 1% (TB rate) x 134/100 (inflation) x 101/100 (risk) x 110/100 (profit) x 115/100 (URA) = 1.71%.
This is not easy because the private sector doesn’t intentionally default, but is hampered by many reasons, many of which are beyond its control.
Finally, every year, Ugandans lose sh120b to foreign reinsurers, money which would increase available credit. The Uganda Reinsurance company is long over-due.
Cutting interest rates is a huge national challenge. Both the Government and the private sector have a role to play. Probably, with more banks being established, the rates will fall due to competition.
The writer is the PSFU director for trade development