Until the late 1970’s Malawi experienced a high degree of
financial repression, with administered interest rates, credit ceilings,
segmented capital markets and excessive intermediation costs. As
part of structural adjustment programs supported by the World Bank
and the IMF, Malawi has been implementing structural reforms in
the financial system for close to two decades now. The main objective
of these reforms has been more efficient mobilization of resources
and optimal resource allocation. One of the most important aspects
of financial reforms was interest rate liberalization.
Policy in Malawi: Past and Present
The Pre- July 1987 Period
Prior to July 1987, the basic structure of interest rates was directly
administered by the Reserve Bank (RBM) of Malawi. As a result, interest
rates were infrequently adjusted during the period before July 1987.
Less attention was paid to underlying macroeconomic conditions,
especially inflation (See Table 1) as well as the demand and supply
of funds. The main preoccupation was to keep interest rates low
in order to reduce government expenditures and to promote private
investment. During the regime of administered interest rates, deposit
rates were set by Reserve Bank of Malawi while lending rates were
set by commercial banks, but subject to a ceiling rate. In March
1980, however, interest rates which were in favour of the agricultural
sector were introduced for the first time. The sector was given
a preferential rate of 1 to 2 percentage points below the prime
Post-July 1987 Period
Rationale for Liberalization
The deregulation or liberalization of interest rates
started in earnest in July 1987 when lending rates were freed. The
advocates of interest rate liberalization and financial development
as growth enhancing economic policies in developing countries have
based their arguments on the theoretical works of Mckinnon (1973)
and Shaw (1973). The policy of low interest rates was considered
an important avenue for promoting investment by keeping interest
costs low. Mckinnon and Shaw, however, showed that the policy of
controlled or administered interest rates was tantamount to “financial
repression”, which is a general distortion in financial prices
like interest rates that reduces the real value of financial assets.
Thus, the overall volume of savings decreases and investment is
naturally adversely affected. The policy prescription for the financially
repressed economy in the Mckinnon Shaw models is then to raise institutional
interest rates or reduce inflation. In line with this thinking and
in order to support the adjustment program, it was decided to gradually
deregulate interest rates. This was done as follows:-
(a) In July 1987, commercial
banks were given the freedom to set their own lending interest rates.
(b) In April 1988, deposit rates
(c) In August, 1988 preferential
interest rates to the agricultural sector were abolished.
(d) By May 1990 all rates became
Since complete interest rate liberalization was
launched, the Bank rate (the rate at which commercial banks borrow
from the central bank) has played a more important role in the financial
system. The role of the bank rate has been enhanced by the development
of the money market and the frequent use of open market operations
as a tool of monetary policy. The Reserve Bank of Malawi now uses
the Bank Rate as an indicator of the stance of monetary policy.
Many times, the adjustment of the Bank Rate has led to adjustment
of interest rates in the financial system. The Bank rate is set
on the basis of interest rates on the Treasury Bill market as well
as developments in inflation rates.
Interest Rate Movements
Before and After Liberalization.
During the period 1985 to 1990, the bank rate and the savings rate
hovered around 10.0 percent with hardly any changes while the minimum
lending rate remained at 13.0 percent. As noted earlier, the full
liberalization of interest rates in 1990 meant that commercial banks
could set their own interest rates. However, in practice during
the period 1990 to 1992 the commercial banks moved their own rates
only after the central bank moved its bank rate. The bank rate was
adjusted at least seven times by monetary authorities mainly to
reduce excess demand for cash, particularly during the period 1994-1995.
This is also the period when Malawi experienced high levels of inflation.
From end 1994, to curb inflationary expectations, the bank rate
was raised to 50.0 percent by May 1995. This was also in line with
Treasury Bill (TB) yield which soared during this period. From 1996,
however, the bank rate has been steadily adjusted downwards and
currently stands at 47.0 percent (as of October 1999). This downward
adjustment resulted from developments in the economy as both TB
yield and inflation followed a downward trend.