Monetary policy: moving towards moderate tightening

Given moderate inflationary pressures during 2010, central banks in Africa often saw room to further ease monetary policies. Nonetheless, in many countries bank-lending rates remained relatively high, and bank credits to the private sector relatively low. This provides further evidence of a relatively weak transmission of monetary policy measures to private sector activity (Kasekende and Brownbridge, 2010). In 2011 monetary policies have to cope with the challenge to control inflation in the light of imported inflation from higher oil and food prices, while at the same time accommodating the economic recovery.

Monetary policies in Africa are expected to gradually tighten to respond to inflation concerns. As in most countries where underlying inflationary pressures are expected to remain subdued, there is no need for vigorous tightening. Policies should focus more on core inflation and inflation expectations rather than on the temporary increase of headline inflation, caused by spikes in food and energy prices. The conditions for monetary authorities are, however, quite different across the individual countries and country groups.

Monetary policies of African countries are implemented within three different frameworks: a) fixed exchange rate regimes, such as the West African Economic and Monetary Union (WAEMU),³ the Economic and Monetary Union of Central Africa (CEMAC)⁴ and the Common Monetary Area (CMA)⁵ in southern Africa; b) targeting of monetary aggregates, such as broad money as intermediate target and reserve money as operational target, and c) inflation targeting. But there are also hybrid systems, with countries (such as Kenya) using elements of the different systems (Kasekende and Brownbridge, 2010).

Inflation continued to decline in 2009 and 2010 in most African countries, independent of their monetary policy frameworks. In fixed exchange rate regimes, the peg with the euro is clearly helping to control inflation. Indeed, countries with exchange rates linked to the euro tend to have lower inflation than countries without such pegging. However, the “one-size-fits-all” monetary policy also entails costs, as the monetary conditions (i.e., the interest rate-exchange rate mix) may be too tight for some countries and too loose for others. For example, in Senegal the inflation rate was below WAEMU average (around ‑1% in 2009 and around 1% in 2010), suggesting that monetary conditions were, perhaps, too tight for this country. In contrast, in Equatorial Guinea, where inflation tends to be above the CEMAC average, the real exchange rate tends to appreciate, which reduces competitiveness of the non-oil sector.

Countries that are targeting monetary aggregates (such as Ethiopia, Tanzania, Uganda and Mozambique) have been more flexible. These countries have used both monetary policies and exchange rate policies to control inflation and at the same time try to sustain competitiveness. While inflationary pressures generally declined, the level of inflation remained mostly higher than in countries with fixed exchange rate regimes. In Ethiopia, Tanzania, Uganda and Mozambique, nominal exchange rates depreciated in 2010, which supported exports but increased import prices. In these countries, inflation amounted to between 9% and 11% in 2010. While in the first three countries inflation was lower than a year earlier, in Mozambique it was significantly higher.

South Africa is pursuing its monetary policy in an inflation-targeting framework. When the rate of inflation approached the lower band of the target range of 3%-6%, helped by the appreciation of the rand, the central bank cut interest rates. In Ghana, another country with inflation targeting, inflation declined significantly, from around 19% in 2009 to 8% in 2010, but it remained above the target of 5%. The appreciation of the (trade-weighted) exchange rate following the earlier sharp depreciation helped ease inflationary pressures.

Over the past five years CEMAC and WAEMU countries had higher inflation than members of the East African Community (EAC) and the South African Customs Union (SACU). At the same time, EAC achieved on average the highest growth among these regions. It is clear that very high inflation is detrimental growth, but at lower levels the interrelationship between inflation and growth is less clear. There could be a trade-off between growth and keeping inflation at a very low level (e.g. through pegging the exchange rate to a low-inflation country or country group like the euro zone) as monetary conditions may become too tight. However, allowing higher inflation is no panacea for attaining higher growth, as other conditions must also be fulfilled. For example, SACU members had on average higher inflation than CEMAC and WAEMU members but not higher growth (see Figure 1.11). This was, however, partly due to the recession, which hit the SACU region particularly hard and led to negative growth in 2009. In the four years prior to this crisis (2005-2008), the SACU region achieved higher growth (4.9%) than WAEMU (3.8%) and CEMAC (4.6%) but still lower growth than EAC (6.9%).