The interest rate in any economy plays a vital role in the financial sector. As it is the cost of borrowing money, or the compensation that we receive for the service of lending money. When we lend money to someone, we are obviously taking a risk, and that demands a price, or compensation. And, it is very important that this rate is determined in a sensible manner.
There are some factors that determine the interest rate in
the economy. Like any other price, interest rate is also mainly determined by the
demand and supply of credit. When there is a huge demand for credit, the rate
of lending will tend to increase. Likewise, availability of funds is also a
factor that determines the price. Excess liquidity in the banking system and
the financial sector in general, shall lead to a lower interest rate, as there
will be increased competition to provide credit.
As Maldives financial sector
is dominated by commercial banks, bulk of lending is done by the banks, and the
financial sector can be described as a ‘bank-based’ sector. For this reason,
banks have exercised their ‘monopoly power’ and established a high lending rate
which ranges between 8 – 13%. On the other hand, the deposit interest rate is
as low as 2.25%. Despite the high interest rates in the banking sector, there
is continuous frustration from the private sector on the issue of ‘access to
finance’. The World Bank ‘Doing Business Report’ also always reports negatively
on the issue. Any report on the financial sector of Maldives would highlight on
it. In short, there exists a huge financing-gap in the real sector of Maldives,
as the required, and desired amount of investments are not financed through the
banking sector. And why should they?
The existing stock of
Government Treasury Bills stands at MVR 11.7 billion. The risk-free one month
T-Bill rate is 7.50%, while the 364 day rate is 9.0%. So, if you can get 9% for one year, risk free
government security, why would the banks ever think of lending to the ‘high
risk’ private sector?
In order to make some sense
out of this ‘outrageous’ interest rates, or in order to explain these high
rates, we may need to look into certain fundamentals of the macro economy. In
August 2010, the one-month T-Bill rate was below 4.50% while the 91-day T-Bill
rate was below 5.50%. This was a time when T-Bills were auctioned in the market
on a weekly basis. Hence, it is a rate determined through a market mechanism.
The year 2010 was an year when Government budget had a deficit of 14.3% of
GDP, and the annual total revenue of the Government was at MVR 6.5 billion.
Fiscal dominance, fiscal discipline, high government demand, you can come up
with all the technical terms to explain/justify.
However, at the end of 2014, the fiscal balance stood at only 3.4% of GDP, and total revenue for the year recorded almost MVR 15 billion. And yet, the one month T-Bill rate is fixed at 7.50%??? Do we still use the terms 'fiscal dominance', and 'lack of fiscal discipline', and high demand to justify these rates?
I think its time we moved towards a sensible interest rate regime. Its time MMA took the lead, and provide sound financial advice to the finance minister.
However, at the end of 2014, the fiscal balance stood at only 3.4% of GDP, and total revenue for the year recorded almost MVR 15 billion. And yet, the one month T-Bill rate is fixed at 7.50%??? Do we still use the terms 'fiscal dominance', and 'lack of fiscal discipline', and high demand to justify these rates?
I think its time we moved towards a sensible interest rate regime. Its time MMA took the lead, and provide sound financial advice to the finance minister.
