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The Bank of Zambia has, effective Monday February 13, 2023, increased the statutory reserve ratio from nine percent to 11.5 percent.
This measure is aimed at stabilising the Kwacha and halting any further depreciation.
What exactly is the statutory reserve ratio and what is the implication of this decision?
Read more:Bank of Zambia moves to prevent further fall in Kwacha value, as poor run persits
According to the Central Bank of Sri Lanka, “the statutory reserve ratio (SRR) is the proportion of the deposit liabilities that commercial banks are required to keep as a cash deposit with the Central Bank.”
Therefore, an increase in the SRR from nine percent to 11.5 percent means, out of the available funds that Commercial banks can potentially lend out or invest, they are now required to keep 2.5 percent more as cash, thereby reducing the money they can use for other purposes.
The effects of this measure are as follows:
Increase in cost of borrowing (lending rate): The increase in dormant cash implies that money will become more expensive.
Banks will therefore charge a higher interest rate on the funds available for lending in order to remain profitable, assuming the demand remains constant.
Therefore, we should expect bank lending rates to increase, making it even more expensive to borrow from banks.
Increase in the gains of saving (savings rate): With lower funds available for lending and investment, banks will raise the savings rate (interest rate paid on savings) in order to attract more funds from people.
This will then lead to more savings with banks.
Reduction in money supply: Due to the above, it will become more expensive to borrow from banks and therefore reducing how much firms will be taking into circulation as cash through borrowing.
At the same time, there will be an increase in the amount of cash leaving circulation into fixed deposits with banks as savings in order to earn a higher return.
The two will therefore result in a reduction in money supply such as reduction in cash and other liquid assets which can easily be turned into cash.
Appreciation of the Kwacha: This will arise from a reduction in money supply (Kwacha) relative to the supply of other currencies on the market.
In simple terms, there will be less Kwacha available to compete when dollars and thus the Kwacha will appreciate since it will become less abundant.
Reduced Economic Activity: An increase in savings by households means less money to buy goods and services and lower borrowing by firms means less investment spending.
Therefore, there will be a negative impact on aggregate demand via consumption and investment.
Further, the appreciation of the Kwacha will reduce export demand while increasing import demand. This will further reduce aggregate demand.
Reduction in Growth: The reduction in aggregate demand will lead to lower growth prospects and ultimately a lower level of Gross Domestic Product (GDP) or output.
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