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Why the drop in inflation to a historical low of 7.5% is unlikely to boost credit demand

Consumer inflation has dropped further by 100bps to a historical low of 7.5% in May 2021 from 8.5% in the previous month. Inflation is now below the midpoint of the central bank’s target range of 6-10% for the first time in history. This was driven by base effects and slowdown in imported inflation arising from the relative stability of the local currency during the period. The low inflation (coupled with a recent policy rate cut) has opened a window of opportunity for commercial banks to reduce lending rates to enhance credit to the private sector to support economic recovery efforts in 2021. However, we doubt that commercial banks would embrace this window of opportunity given that they have historically struggled (or are unwilling) to quickly transmit such gains to the private sector via cheaper credit.

We believe that the sharp decline in inflation by 100bps to 7.5% reinforces the central bank’s decision to cut the benchmark monetary policy rate by 100bps to 13.5% last month. This is likely to sustain the downward pressure on treasury yields in the short-term to help government lower its cost of funding, which is needed to help the authorities manage the country’s huge debt service burden and a precarious fiscal position. Short and medium term treasury securities have been on a downward trend since the beginning of the year as shown below.

While the government is set to reap the benefits via lower cost of funding, the challenge would be to transmit the benefits to the private sector via lower lending rates, especially given that commercial banks take time to adjust their lending rates in response to positive market developments in Ghana. The latest data from the central bank shows that the average lending rate only dropped marginally by 170bps since the start of the year to April 2021 despite inflation declining by 1.9 percentage points over the same period.

While most banks have generally tightened credit conditions in response to the pandemic, we believe that the failure to transmit lower inflation and policy rates into cheaper credit for the private sector is also hampering credit demand. It is clear that attempts by the authorities to resolve the conundrum by devising new methods for calculating base lending rates are not having the desired effect on credit demand at the moment. And the status quo is likely to remain until the authorities find a way to make commercial banks more responsive to policy decisions and macroeconomic data releases.

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