Interest rate liberalisation and economic growth in SADC countries

The pioneers of financial liberalisation, McKinnon (1973) and Shaw (1973) argue that inter-est rates determined by market forces have a positive effect on economic growth rates. Inter-est rates that are kept at low levels through the intervention of a central bank discourage sav-ings and capital accumulation, and distort the allocation of resources. Interest rate liberalisa-tion results in higher real interest rates which could have a positive effect on savings, invest-ments and economic growth (Ang & McKibbin 2007). Interest rate liberalisation also reduces capital flight and encourages capital inflows by increasing return for investors which supple-ments domestic investments. Shaw (1973) argued that interest rate liberalisation promotes financial development by encouraging savings and increasing the availability of funds for lending purposes. The study provides an empirical analysis of the channels through which interest rate liberalisation impacts on economic growth in SADC countries for the period 1990 to 2015. The study is motivated by the concerns on the impact of interest rate liberalisation on eco-nomic growth in the period after the 2008-’09 global financial crisis as well as concerns that interest rate liberalisation increases the likelihood of financial crises. Higher interest rates resulting from interest rate liberalisation may increase the likelihood of financial crises by encouraging risk-taking on the part of banks in an attempt to take advantage of higher returns. Authorities in most countries have reduced interest rates in an attempt to boost aggregate demand, which is expected to speed up the recovery from the crisis. However, the lowering of interest rates may result in a decrease in savings and investments, which are the main drivers of long-term economic growth. Real interest rates below equilibrium may encourage banks to take more risks in their lending practices in order to earn higher returns which may result in an increase in non-performing loans. The influence of interest rates on financial crises has thus received considerable attention since the onset of the 2008-’09 global financial crisis and this thesis contributes to the literature by determining how interest rates impact on economic growth in SADC countries and whether interest rate liberalisation increases the likelihood of financial crises. The study examines the relationship between interest rate liberalisation and economic growth through different channels. These include savings and investments, capital flows and finan-cial development. The study uses the Pooled Mean Group (PMG) estimator proposed by Pesaran et al (1999) to estimate the effect of interest rate liberalisation on economic growth through the abovementioned channels. The study also examines whether interest rate liberalisation increases the likelihood of financial crises. This is estimated using the logit model, due to the binary nature of the dependent variable. The results provide limited support for the McKinnon and Shaw hypothesis. Interest rate liberalisation has a positive effect on economic growth through higher savings and investments. Interest rate liberalisation has a positive outcome on capital inflows, which indicates that the prospect of earning higher returns encourages foreign investors to invest in the domestic economy. However, capital inflows do not enhance economic growth. This could be due to the low levels of human capital in SADC countries. Interest rate liberalisation boosts financial development through higher savings and invest-ments. However, financial development has a negative effect on economic growth because of the link between financial development and financial crises. The results show that interest rate liberalisation decreases the likelihood of financial crises directly, however, it increases the probability of financial crises indirectly through financial development. This suggests that the major cause of financial crises in the region is the low levels of institutional quality and lack of adequate supervisory frameworks to monitor the functioning of the financial system. Therefore, the results imply that the negative impact of interest rate liberalisation may outweigh the positive effect of higher savings and investments in SADC countries. A number of policy recommendations can be drawn from the study. Liberalisation of interest rates has a positive effect on economic growth through savings and investments. However improving the levels of institutional quality is vital for preventing financial crises. Interest rate liberalisation may not have a direct influence on financial crises, but higher levels of fi-nancial development emanating from higher interest rates increase the likelihood of financial crises. Therefore, a sound monitoring framework is necessary for the benefits of financial liberalisation to be realised. Also, investment in education, training and research and development is a necessity so as to increase levels of human capital, which in turn may allow the region to reap the benefits of capital inflows