IT IS BY NOW GENERALLY RECOGNIZED that the existence of externalities and other market imperfections justify government intervention in financial markets. Since in most developing countries the financial system can be broadly characterized as being both underdeveloped and oligopolistic, it is not surprising to find that government intervention in the financial markets of these countries is pervasive. The relevant question to ask in such situations is not whether government intervention should be eliminated altogether but how these intervention policies, imperative as they are, can be made less distortion accentuating or more distortion attenuating. Regarding credit market imperfections, which is the concern of this paper, it has been found that government intervention has often tended to be distortion accentuating (Galbis, 1981; McKinnon, 1981) for two main reasons. First, in less developed countries that are afflicted by low income and investment, low interest rates are considered to be investment inducing and hence justified. Second, deliberate decisions to maintain low and stable interest rates are taken to countervail the perceived baneful effects of the very high interest rates prevailing in the unorganized credit market. However, it is little realized that, in the face of inflationary pressures, low interest rates in nominal terms often culminate in negative real interest rates. Thus, the financial markets, imperfect as they are to begin with, are distorted further, affecting the efficiency and pace of the growth of the economy (McKinnon, 1973; Shaw, 1973; Khatkhate, 1980). The important issue is, therefore, how to prevent government intervention from being distortion accentuating. For this reason, it seems essential to evolve rational criteria by recourse to which the authorities can determine the level and structure of money interest rates in the imperfect credit markets of less developed countries. It is true that there is not one single criterion but many alternatives on which they must base their decisions. These decisions depend on the short-term and long-term objectives of economic policy at any given time and the current phase of the economy and its relationship to the outside world. Where there are multiple criteria, the weight to be assigned to each is also important. Such difficulties notwithstanding, it is still essential to search for a set of guidelines that, combined with judgmental considerations, would permit the determination of interest rate levels that would be compatible with the macroeconomic objectives of a given country.
The purpose of this paper is to consider basic criteria for the determination of appropriate interest rate levels in the context of selected West African countries. The countries have been chosen to provide varying institutional and policy frameworks, so that the discussion on interest rate policies should assume a sufficiently general tone. The countries are Ivory Coast and Senegal from the CFA franc area; three former British colonies that were part of the now defunct West African Currency Board—The Gambia, Ghana, and Sierra Leone; two former French colonies that have withdrawn from the CFA franc area—Guinea and Mali; two former Portuguese colonies—Cape Verde and Guinea-Bissau; and Liberia, which is sui generis, since it uses a foreign currency, the U.S. dollar, as legal tender. All these countries are basically agricultural and, with the exception of Ivory Coast, have a per capita income of between SDR 107 and SDR 383.
In Section I of the paper the characteristics of the financial systems in West Africa are described; Section II discusses the interest rate policies pursued in those countries over the 1970s; and Section III contains some general considerations relevant to devising appropriate interest rate policies, which are then applied to the interest rate structures in West Africa. The last section contains the conclusions of the paper.
Bhaduri, Amit, “On the Formation of Usurious Interest Rates in Backward Agriculture,” Cambridge Journal of Economics, Vol. 1 (December 1977), pp, 341–52.
Bottomley, Anthony, “The Premium for Risk as a Determinant of Interest Rates in Underdeveloped Rural Areas,” Quarterly Journal of Economics, Vol. 77 (November 1963), pp. 637–47.
Brown, W. W., and C. J. Santoni, “Unreal Estimates of the Real Rate of Interest,” Federal Reserve Bank of St. Louis, Review, Vol. 63 (January 1981), pp. 18–26.
Chandavarkar, Anand G., “Some Aspects of Interest Rate Policies in Less Developed Economies: The Experience of Selected Asian Countries,” Staff Papers, Vol. 18 (March 1971), pp. 48–112.
Dasgupta, Partha, Amartya Sen, and Stephen Marglin, Guidelines for Project Evaluation, United Nations Industrial Development Organization (New York, 1972).
Galbis, Vicente (1977), “Financial Intermediation and Economic Growth in Less Developed Countries: A Theoretical Approach,” Journal of Development Studies, Vol. 13 (January 1977), pp. 58–72.
Johnson, Omotunde E. G., “Direct Credit Controls in a Development Context: The Case of African Countries,” in Government Credit Allocation: Where Do We Go From Here? (San Francisco, 1975), pp. 151–80.
Khatkhate, Deena R. (1972), “Analytic Basis of the Working of Monetary Policy in Less Developed Countries,” Staff Papers, Vol. 19 (November 1972), pp. 533–58.
Khatkhate, Deena R. (1980), “False Issues in the Debate on Interest Rate Policies in Less Developed Countries,” Banca Nazionale del Lavoro, Quarterly Review (June 1980), pp. 205–24.
Khatkhate, Deena R. and Delano P. Villanueva, “Operation of Selective Credit Policies in Less Developed Countries: Certain Critical Issues,” World Development, Vol. 6 (July/August 1978), pp. 979–90.
McKinnon, Ronald I. (1981), “Financial Repression, Liberalization and the LDCs,” in The World Economic Order: Past and Prospects, ed. by Sven Grassman and Erik Lundberg (New York, 1981).
Ness, Walter L., Jr., and Rosanne H. Rebelo da Silva, “Análise Conjuntural Financeira das Companhias Abertas,” Revista Brasileira de Mercado de Capitals, Vol. 5 (May/August 1979), Supplement No. 5.
Tanzi, Vito, “Inflationary Expectations, Economic Activity, Taxes, and Interest Rates,” American Economic Review, Vol. 70 (March 1980), pp. 12–21.
Wai, U Tun, “Interest Rates Outside the Organized Money Markets of Underdeveloped Countries,” Staff Papers, Vol. 5 (August 1956), pp. 249–78.
Mr. Leite, an economist with the Central Banking Department, holds degrees from Pontificia Universidade Catolica do Rio de Janeiro, Universidade do Estado da Guanabara, and Johns Hopkins University.
The extremely low ratio of financial savings to GDP in Liberia might be due partly to an underestimation of the U.S. banknotes circulating in the country. However, even correcting for that, the ratio of financial savings to GDP would undoubtedly remain low.
Nevertheless, to the extent that the resources provided to the government finance expenditures with higher social rates of return than the crowded-out private sector expenditures, the substitution is clearly beneficial to the economy.
Throughout this paper, real interest rates were obtained by subtracting the inflation rate, as given by the consumer price index, from the nominal interest rate. This can only be considered as a first approximation of the expected real rate.
However, one should take into account short-term difficulties in given sectors that might temporarily depress the rates of return, even in the more efficient sectors.
An alternative, more market-oriented approach is for the government to fix the maximum spread between the average cost of funds to the financial intermediaries and their average earnings, while allowing them to set both lending and deposit rates. If the spread allowed by the authorities takes into account “normal” intermediation costs, risks, and profits (but not excessive monopolistic profits), the optimizing behavior of the financial intermediaries, even where there are oligopolistic structures, would tend to ensure an interest rate structure similar to the equilibrium rates under perfect competition. In principle, international comparisons could provide an initial idea of “normal” spreads. However, one should be careful when making international comparisons, since reserve requirements, portfolio regulation, and so forth, may vary from country to country.