Why the interest rate matters

Last week the South African Reserve Bank increased the interest rate for the first time in approximately three years. As someone who doesn’t deal in usurious transactions you may be wondering: why should I be bothered?

The interest rate is an important indicator of a number of factors in the South African economy. It is also an important tool that is used to influence fundamental aspects of the economy. These include:

Inflation. Inflation is essentially general increase in the price of goods and services in the economy. The South African Reserve Bank (SARB) tries to maintain inflation within a 3% to 6% band. The interest rate is generally inversely correlated to the rate of inflation. In other words, when inflation goes up the SARB tends to increase interest rates to bring it back down.

Currency. There are numerous factors that affect the value of a currency, interest rates being one of them. An increase in the interest rate may make a country more favourable to foreign investment which could result in an appreciation of a currency. This in turn could lead to more favourable access to important imports such as oil.

Shariah compliant financing. While the interest rate may not be changed to determine the cost of shariah financing, there is often a correlation between the two. When interest rates are high, so is the cost of shariah compliant financing as it takes market conditions into account.

In addition to the interest rate there are many other tools which are used to stabilise and grow the economy. Unfortunately, they don’t always work in harmony.

Allah knows best