Earlier this year, the Central Bank of Jordan decided to raise the interest rate on the dinar by one quarter of a percentage point, applicable to all its dealings with commercial banks.
The decision did not immediately alter the level of interest rates used by the banking system. Interest rates on the deposits of the public did not rise. Interest rates applicable to the credit facilities did not change, and the margin between the rate of interest payable to depositors and the interest rate charged to borrowers remained on the high side.
What the Central Bank did was to set the tone. It confirmed a new direction towards higher interest rates on the dinar. This, of course, influenced expectations.
The main factor bank managers take into account in the present uncertain circumstances is the risk element. A borrower being ready to pay high interest rates would not tempt the bank manager to lend to him if a question mark exists on his credit worthiness. Competition among banks is extremely high to attract good borrowers that are in short supply. Such sought-after customers do not habitually shift their business from one bank to another.
In the case of deposits, banks do not seem eager to attract more because they already have high liquidity and surplus funds deposited with the Central Bank in the one-night deposit window, earning interest lower than the actual cost of the funds.
Under the present circumstances, and for good reason, safety, as perceived by banks, has priority over profitability.
As far as the Central Bank is concerned, the decisive factor influencing its thinking when considering interest rates is to maintain the dinar's attractiveness, to enable it to give higher returns than the dollar or the euro, as a premium to compensate holders for the perceived risk of the local currency.
Dollarisation is not welcome and must be confronted. Apparently, the Central Bank felt this way when it observed the gradual decline of its foreign exchange reserves during the first half of this year, and moved to halt the trend.
In this respect, the question one may ask is why would some observers want to raise the interest rate on the dinar?
Advanced countries do raise interest rates on their currencies in order to suppress inflation by cooling down an overheated economy.
They try to curb demand on investments and consumption, but this state of affairs is not applicable to the Jordanian economy, which is rather cool, if not in a kind of moderate recession. If anything, the Jordanian economy may need more incentives to be activated, rather than brakes to reduce a non-existing speed.
Despite the relative slowdown of the Jordanian economy at this point in time, monetary indicators are giving positive readings.
During the last 12 months, money supply rose by 10.9 per cent, public deposits rose by 9.4 per cent and credit facilities registered a high growth rate of 12.1 per cent.
Banks' profits in the first half of 2011 were higher. One can speculate that this relative banking prosperity is an early indicator of an impending economic activity.
© Jordan Times 2011
