Tanzania Interest Based Monetary Policy Framework and Implication on FDI

Tanzania Adopts an Interest- based Monetary Policy Framework and Its implication on Foreign Direct Investment in Tanzania 

26 January 2024

By Amne Suedi

Tanzania’s interest – based monetary policy framework is a move to improve investment climate in Tanzania and to create investor confidence. In case you missed it, earlier this year, the Bank of Tanzania (BOT) announced that it is adopting an interest-rate based monetary policy framework so as to stabilize the economy and control inflation. It, furthermore, has set the policy rate at 5.5%

For those who have not read the announcement yet, don’t worry I have 😊 and I am going to break it down for you highlighting the key points:

1. Monetary Policy Definition:

   – Monetary policy involves decisions and actions taken by the BOT to influence the money supply in the economy and the cost of borrowing. The BOT uses several tools to define its monetary policy and to achieve its objectives. 

2. Monetary Policy Framework:

   – Interest- based monetary policy framework focuses on maintaining price stability to support balanced and sustainable economic growth.

   – The framework aims to steer interbank cash market interest rates in alignment with the Central Bank policy rate.

3. Objective of Monetary Policy:

   – The primary objective is to maintain price stability, defined as a low and stable rate of inflation over time.

   – The inflation target is set at 5 percent over a medium-term period of 3-5 years, consistent with regional economic communities.

4. Intermediate Target:

   – The Bank controls inflation and facilitates economic growth by setting the policy rate (CBR), which is consistent with the inflation forecast. The Central Bank has just set the policy rate, CBR, at 5.5% for the first quarter of 2024. 

5. Operating Target:

   – The Bank steers the 7-day interbank cash market interest rate (operating target) along the policy rate to achieve inflation and output objectives.

   – The chosen interbank rate is considered stable and has a strong relationship with the policy rate.

6. Monetary Policy Instruments:

   – The Bank uses various instruments, including repurchase agreements (repo and reverse repo), open market operations, statutory minimum reserve requirement ratio (SMR), discount rate, and standing lending facilities.

   – These instruments manage the quantity of money supply, influence the cost of borrowing, and maintain structural liquidity.

7. Monetary Policy Communication Strategy:

   – The Bank prioritizes transparency in its decisions and actions.

   – Communication involves post-MPC meetings with bank CEOs, public announcements through the media, and the publication of MPC meeting statements and periodic reports.

   – Reports are accessible on the Bank of Tanzania website.

Overall, the outlined monetary policy framework underscores the importance of transparency, effective communication, and the use of various instruments to achieve the Bank’s primary objective of maintaining price stability for sustainable economic growth. This approach aligns with global best practices in central banking and provides stakeholders with the information needed to understand and navigate the monetary policy environment in Tanzania.

The monetary policy framework outlined by the Bank of Tanzania has several implications for foreign direct investment (FDI). While the direct impact on FDI may not be as pronounced as in the case of exchange rate or interest rate targeting policies, the overall economic stability and conditions influenced by the monetary policy can significantly affect the attractiveness of Tanzania as an investment destination. 

Let us break down the implications here:

1. The primary objective of maintaining price stability through a low and stable rate of inflation contributes to overall economic stability. A stable economic environment is generally attractive to foreign investors who seek predictability and reduced investment risk.

2. The explicit inflation target of 5 percent over a medium-term period provides clarity to investors about the country’s commitment to price stability. Lower and stable inflation rates create a favorable environment for businesses planning long-term investments.

3. The monetary policy framework influences interest rates, affecting the cost of borrowing. For investors considering long-term projects, the stability of interest rates is essential. If the BOT’s policies effectively control inflation and maintain interest rate stability, it can positively impact FDI.

4. While the framework does not explicitly target exchange rates, stability in short-term interest rates and overall economic conditions can contribute to exchange rate stability. A more stable exchange rate environment is generally preferred by foreign investors.

5. The BOT’s  focus on maintaining an adequate level of liquidity in the economy is relevant for the smooth functioning of financial markets. Efficient financial markets can be attractive to foreign investors looking for well-regulated and liquid markets.

6. The BOT’s commitment to transparency and effective communication can enhance investor confidence. Regular communication through post-MPC meetings, media announcements, and published reports allows investors to stay informed about the economic conditions and policy directions.

7. The combination of price stability, clear policy targets, and effective liquidity management contributes to creating a conducive business climate. FDI is often attracted to countries with a favorable business environment.

8. Investors assess risks before committing to FDI. The BOT’s efforts to maintain economic stability and manage inflation contribute to a lower risk perception, potentially making Tanzania more attractive to foreign investors.

9. Different sectors respond differently to monetary policy conditions. For example, stable interest rates can benefit sectors that heavily rely on financing, such as infrastructure and manufacturing, potentially influencing FDI patterns across industries.

Tanzania’s adoption of an interest-based monetary policy framework signals a commitment to stability, transparency, and global best practices. This strategic move not only improves the country’s “appeal” to foreign investors seeking predictability and reduced risk but also positions Tanzania as a reliable and integrated player in the regional and international economic landscape. As the framework unfolds, its success in maintaining economic stability and achieving stated objectives will likely propel Tanzania into a more prominent role on the global stage, attracting increased foreign direct investment and fostering sustainable economic growth!