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Local rate control

Local rate control

commentbyjameslowry.jpg
commentbyjameslowry.jpg

While Western rates hit rock bottom, depositors can get more than 7 percent in Cambodia

Although the dollar is widely used in Cambodia, interest rates for deposits and loans bear no reflection to US interest rates in major trading centres around the world.

The National Bank of Cambodia (NBC) manages dollar and riel money supply but does not set cash rates for the dollar, leaving interest rates to the market.

The majority of bank deposits and loans are denominated in dollars, but money changers, foreign currency dealers and microfinance institutions are prolific in their riel-lending.

So what drives interest rates in Cambodia?

Interest rates are deemed the "future price of money". Supply and demand play a large role in determining prices, which are affected by economic and investment activity.

In many countries, central banks control official cash rates to influence the demand for money, thus inflation, through manipulating consumption. As the NBC has no influence over US monetary policy - and is limited in its ability to influence local rates - here they have increased.

The US Federal Reserve has lowered its benchmark target rate to between zero and 0.25 percent, a move that left it no room to cut rates further.

At the other extreme, the Central Bank of Zimbabwe increased rates for borrowing to 800 percent in 2007 to try to tackle hyperinflation!

But the central bank here is not completely hamstrung.

In early 2008, property activity led to increasing inflation.

To stem economic activity - and cut inflation - the NBC required commercial banks to double their reserve ratio requirements from 8 percent to 16 percent.  This reduced the availability of surplus deposits to fund new loans.

As property activity and price growth cooled, inflation also fell. In response to the market conditions, the NBC cut the reserve ratio from 16 percent to 12 percent. The additional liquidity represents about one month of lending.

Local liquidity is related to M2 - or broad - money supply as regulated by the NBC. While the NBC can manage supply of riels, the control of dollars is not easy. Key sources of dollars have included foreign direct investment (about US$800 million in the past two years), foreign aid and private remittances, largely from Cambodians living abroad.

As banks raise most of their funding for dollar loans in Cambodia from domestic dollar deposits, and deposit interest rates are a function of the demand for liquidity in the country, the rates paid on dollar deposits have continued to rise in the past 12 months by as much as 3 percent per year.

As such, local depositors can enjoy very high interest rates on their dollar deposits in Cambodia compared with low rates paid in most of the world.

So, although central banks around the world are lowering official cash rates to stimulate business activity, because of the unique monetary system in Cambodia, interest rates have remained high.

There is, therefore, a need to improve monetary policy options to enable the country to respond to the extreme economic conditions it is currently facing.

_____________________________________________________
James Lowry is head of corporate and institutional banking at ANZ Royal Bank Cambodia.

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