In this industry update, we provide clarification on the Bank of Tanzania's (the BOT) adoption of the interest rate based monetary policy framework 2017/2018 (the Policy Framework).
Contrary to popular belief, the Policy Framework does not place caps on interest rates. In a document dated 18 December 2017 published on the BOT website, the BOT clarified that the Policy Framework targets interbank cash market rates which is the rate at which banks lend money to each other.
The BOT's central role is to ensure stability of prices which is done by:
i. monitoring CPI Basket which focuses on inflation;
ii. monitoring prices which focuses on interest rates; and
iii. monitoring foreign currency which focuses on exchange rates.
The Policy Framework outlines the BOT's decision to either increase or decrease the flow of money into the country. The Policy Framework published on 17 June 2017 indicates the BOT's decision to move from providing quantitative based policy frameworks to providing price based policy frameworks. This means that instead of providing targets that speak of increments/decrements in Tanzanian shillings (i.e. in relation to the average quantity of reserve money), the BOT will indicate an increase or decrease using the per cent interest rate. In essence, the language used by the BOT has changed.
The BOT sees this change from quantitative targets to interest rate targets as beneficial to the market as it is less technical to calculate and therefore easier for the public to better understand the Policy Framework.
It has also been indicated that the introduction of the Policy Framework will increase competition in commercial banks by ensuring that the commercial banks' interbank lending rate is in line with policy rates provided by the BOT. It is expected that this will also provide investors and borrowers a base to bargain from as they will be aware of the interest rate at which the commercial banks are borrowing from the BOT and therefore can negotiate better interest rates. Furthermore, the BOT believes that this will also reduce interest rate volatility.
The Policy Framework has been used widely across East Africa and the developed world. Its adoption in Tanzania is in part due to the broader commitment to modernise the monetary policy framework and harmonise the monetary policy practices across the East African Community. It is crucial that the Policy Framework is not confused with interest rates capping which is a mandatory requirement that puts a ceiling on interest rates commercial banks may demand.
It is interesting to note that interest rates capping was implemented in Kenya in 2016 and has caused interference to the functioning of the market and adverse effects to the economy to such a large extent that the Central Bank of Kenya is considering repealing the law that put the cap into effect.