High interest rates create runaway debtors and offer little help to the economy, argues Salah El-Amrousi* The bad loans crisis has brought to the fore the question of interest rates. Many have blamed high interest rates, among other things, for the defaulting of major borrowers and their subsequent flight from the country. The crisis, by all accounts, is of massive proportions. And, like any crisis of considerable political magnitude, it is often downplayed. According to the most conservative official figures, non- performing loans amount to anything between 1 per cent and 3 per cent of all loans. Since loans total LE250 billion, bad loans are thought to be between LE2.5 billion and LE7.5 billion. This is the most conservative estimate. And yet, it is mind-boggling for the vast majority of Egyptians living on modest wages. These estimates are also much higher than the total sum of loans offered to small businesses over the past decade. The general picture is equally disturbing. According to economist Salwa El-Antari, 343 clients obtained just under half (42 per cent) of the entire credit supplied by the banking system. Of these, 28 clients obtained over a quarter (26.7 per cent). Of those, eight obtained LE12.4bn. Some analysts have started to blame interest rates more than the actual defaulters for the preponderance of non-performing loans. For the past two years, analysts have noted that private businesses have been driven to desperation, or outright bankruptcy, because of their troubled relations with the banking system. Many pointed the finger at interest rates as the main cause of stagnation and default. Meanwhile, the banking system began to act suspicious, if not paranoid, toward its customers, which made borrowing much harder for business. The common grievance was that interest rates of 16 per cent or so make no sense in an economy where the inflation stands at 4 per cent or less. In an article in Al-Ahram (16 November 2000), businessman Sherif Delawar calls for lower interest rates and partial debt forgiveness, noting some cases in which the borrowers have already paid, in interest alone, more than the original sum of the debt. Delawar noted that banks are making massive profits because of the 6 per cent or 7 per cent difference between the lending and borrowing rates. Some may argue that this wide difference is justified by the high lending risks in the country. Generally speaking, the policy of high interest rates is hardly defensible. But, can we really start defending the crooks and con- men who played the banking system for their own gain? The right approach to the problem of interest rates, I believe, is to look at the performing, not the non-performing, loans. Interest rates average 16 per cent or 17 per cent (or even 22 per cent, if we consider the rates in 1991, just after the government launched its liberalisation programme in consultation with the World Bank and the IMF). This means that the businesses that continue to service their debts without default have made a profit of at least 25 per cent or 30 per cent. It has been noted that some businesses, the assembly factories for example, have made 70 per cent to 80 per cent profits on average. This kind of profit margins is unattainable in productive sectors, particularly manufacturing, where low profits or even losses are expected in the earlier stages. This means that the government should subsidise these sectors, not burden them with heavy interest rates. My point is that high interest rates nudge the economy toward commercial and real estate activities. Assembly manufacturers, who are practically commercial agents with factories, can afford high interest rates. These types of business may be profitable in the short term, but they encourage speculation, tolerate corruption, and tend to overheat the economy until the bubble bursts and a new slump develops. High interest rates, in other words, are a sure recipe for recession. In the meanwhile, dodgy businessmen may be able to make profit, even pay their debts, through speculative transactions in trade and real estate. But when the market turns, they are liable to sustain tremendous losses. The non-performing loans are a result of this exact scenario, of this lack of attention to production and industry. So, why do we keep interest rates so high? High interest rates are a tool of economic reform. Interest rates should normally be higher than inflation, so as to remain positive. This is why the World Bank and the IMF advised Egypt to raise the interest rates to 20 per cent or 22 per cent in 1992-93, as part of their reform package. Since then, the inflation rate has dropped to 4 per cent or less, but the interest rates were kept at 16 per cent or 17 per cent. Why? According to the neoclassical thinking that dominates the World Bank and the IMF, interest rates should be kept high in developing countries so as to encourage savings. Neoclassical theorists advise countries in Egypt's situation to avoid capital- intensive and focus on labour-intensive investment. This would, presumably, help these countries alleviate unemployment. High interest rates are supposed to force investors to maintain high quality and keep away from low-profit activities. This is just the reverse of what development theorists advocate. The latter's favourite method is to supply cheap funding for fledgling industries. The neoclassical school disagrees, for low savings mean low investment. The dilemma is obvious: industrial investment requires low interest rates, but it cannot happen without real savings, and low interest rates could depress savings. This dilemma never bothers neoclassical theorists, for they are not interested in industrialisation as such. If the market forces do not encourage industrialisation, their argument goes, you don't need it. Development theorists beg to differ. But let's move from theory to practice. How did neoclassical policies fare in Egypt so far? Official figures indicate that the current policies have singularly failed to boost savings. Domestic savings in 1995-96 stood at 12.7 per cent of GNP. This ratio dropped to 11.7 per cent in 1999-2000, before moving up slightly to 12.2 in 2000-01. The estimated figure for 2001-02 is 10.4 per cent. Throughout this period, investors focused on trade, real estate, and assembly manufacturing, in search for high profits. The result was recession, a liquidity crisis, an oversupply of real estate, as well as unemployment and non- performing loans. To make things worse, the trade deficit grew as the economy failed to generate sufficient exports. Why have not savings grown, despite the strong argument made by the neoclassical theorists? The answer is complicated. Even more so if one is to note that Southeast Asian countries managed to boost their saving rates considerably without resorting to high interest rates. South Korea, for example, had negative interest rates during parts of the 60s and 70s, and still managed to boost its savings from 1 per cent in 1960 to 37 per cent in 1990. How was this done? To answer this, one should keep in mind that, under capitalism, capital accumulation is achieved through the reinvestment of capital profit (the value added). In other words, the capitalist class provides the bulk of the savings, through the intercession of the banking system. Interest rates, therefore, serve merely to redistribute income among the capitalist classes. Higher interest rates mean more profits for monetary capital, whereas lower interest rates mean more profits for industrial capital. The savings of the capitalist classes could be indirectly increased by restricting certain types of luxury spending in developing countries, and by discriminating against loans going to commercial and speculative activities. Such intervention requires the active involvement of the state. Other classes, such as the middle class and the petit bourgeoisie, contribute to capital accumulation. Their contribution appears in official statistics under the label "household savings". The latter is what neoclassical theorists recognise as the only source of savings, and fail to make any distinction between its role in advanced countries and in developing economies. In advanced economies, household savings are sizeable, considering the prosperity of the middle class, the petit bourgeoisie, and even parts of the working class. In circumstances where the economy has a comprehensive social security network (health insurance, unemployment benefits, etc.), a large part of household savings finds its way to capitalist accumulation through the banking system, the insurance companies, and the stock market. In developing countries, however, household savings have never played a major role, because the petit bourgeoisie and the middle classes (despite their large number) are economically weak. This is something that the neoclassical theorists fail to understand. Higher interest rates, their favourite recipe, will not succeed in stimulating household savings. The only way to raise the contribution of petit bourgeoisie and the middle classes to national savings is through compulsory means. In Korea, for example, the government set up the National Investment Fund in the 70s to marshal part of the insurance money of government staff and bank assets to finance a programme for developing heavy and chemical industry. As the economy grows, domestic savings do as well, but this too is not connected to the interest rate. In most Southeast Asian countries, particularly where social security systems are not fully developed, families attempt to save large proportions of their income to provide for their future. The equivalent in the Egyptian case is the savings made by expatriate labour, which are more sensitive to the exchange rate and the conditions of the real estate market than to interest rates. What the Korean example shows is that growth, not interest rates, is the real determinant of savings. Higher interest rates, if they hamper economic growth, would also impede savings. What the state should do is create the right dynamic between profits and investment. In the Asian example, the state used its foreign loans to fill the gap between savings and investment (while boosting domestic savings through compulsory means). This stage was followed by one where profits provided the main source for savings and capital accumulation. Later on, the state accelerated capital accumulation by discriminating against speculative activities while keeping the interest rate low for industrial sectors. This formula would be more helpful to Egypt than the current one, where interest rates are kept high, speculators run amok, and, with the slightest tremor in the economy, run away. * The writer is an economist with the Arab Research Centre.
