Interest Rate Parity in Africa Diery Seck July 4th, 2017

African Investors deposit substantial amounts overseas although African economies need to mobilize large amounts; WHY? No investment vehicles available in Africa Tax evasion and loot from corruption To avoid instability and institutional risk To arbitrage from lack of parity between savings rates in Africa and Overseas

Initial remarks The study will focus on the economic motives: Interest rate arbitrage Sample: Most African countries with sufficient data, 1990 – 2016 Data source: International financial Statistics, IMF, Annual data US used as benchmark

Theory of Interest Rate Parity Under assumptions of 1) capital mobility and 2) perfect substitutability, in equilibrium investors will be indifferent to deposit interest rates that are available in banks of country A and country B.

Investor has 2 investment options: Option A: At home deposit 10.000 units of Local Currency and earn Final income: 10.000 LC *(1+iLC) ; iLC : interest rate on local currency   Option B: - Buy US Dollars for 10.000 units of Local Currency: 10.000/St Deposit the US Dollar amount into a US Bank; St = Spot exchange rate At the end of the period he will collect (10.000/St)*(1+iUS) *E(St+1)   E(St+1) = Expected Exchange rate at end of period iUS = interest rate on US deposits Under Interest Rate Parity, Options A and B are equivalent

Uncovered Real Interest Rate Parity: (1+iLC) = (E(St+1)/ St) * (1+iUS)   (1+iLC) = (E(St+1)/ St) * (1+iUS)

Factors that can impede Interest Rate Parity Significant transaction costs Tax implications on interest income and on gains from exchange rate transactions Political risk Different risk levels of US vs Home assets Different levels of liquidity of home vs foreign assets

The Empirical Evidence: 3 tests Test 1: Are real deposit interest rates POSITIVE in Africa? Test 2: Are real deposit interest rates HIGHER in AFRICA than in the US Test 3: Does the Uncovered Interest Rate Parity hold for African Economies?

Average Inflation Rates of African Countries 1990-216   Average % USA 2.37 ALGERIA 9.07 EGYPT LIBYA 3.60 MOROCCO 2.51 BENIN 4.69 CAMEROON 3.66 COTE D'IVOIRE 3.96 SENEGAL 2.71 TOGO 4.35 BOTSWANA 8.61 CAPE VERDE 3.36 GHANA 19.77 KENYA 12.25 MAURITIUS 5.56 NIGERIA 19.21 SEYCHELLES 4.87 SOUTH AFRICA 7.06 Source: IFS, IMF, June 2017

Result # 1: Real Deposit Interest Rates Over the period 1990 – 2016 (26 years), most African countries have registered positive real deposit interest rates

Average Real Deposit Interest Rates 1991-2016 USA 0.28 ALGERIA -2.68 EGYPT -0.22 LIBYA 1.22 MOROCCO 2.57 BENIN 5.22 CAMEROON 1.34 COTE IVOIRE 5.49 SENEGAL 6.22 TOGO 4.95 BOTSWANA 0.00 CAP VERDE 4.92 GHANA -1.06 KENYA MAURITIUS 3.31 NIGERIA -4.75 SEYCHELLES SOUTH AFRICA 2.63

Result # 2: Difference of Real Interest Rates in Africa and USA Over the period 1990 – 2016 (26 years) average real deposit interest rates were higher in most African countries than in the USA

Difference Between Average Real Deposit Interest Rates of African Countries and USA 1991-2016, in % Country Difference ALGERIA -2.684 EGYPT -0.224 LIBYA 1.225 MOROCCO 2.577 BENIN 5.231 CAMEROON 1.337 COTE IVOIRE 5.501 SENEGAL 6.230 TOGO 4.959 BOTSWANA -0.420 CAP VERDE 4.918 GHANA -1.062 KENYA -0.190 MAURITIUS 3.308 NIGERIA -4.753 SEYCHELLES 1.217 SOUTH AFRICA 2.627

Result # 3: Interest Rate Parity Over the period 1991 – 2016, Interest Rate Parity relative to the US Dollar did not hold and was in favor of African Countries

Differential Between Local Deposit Rate and Arbitrage US Rate COUNTRY DIFFERENTIAL ALGERIA -4.490 EGYPT -7.486 LIBYA -1.512 MOROCCO -3.223 BENIN -6.892 CAMEROON -3.644 COTE IVOIRE SENEGAL TOGO BOTSWANA -7.037 CAP VERDE -7.094 GHANA -16.799 KENYA -7.371 MAURITIUS -7.959 NIGERIA -10.577 SEYCHELLES -4.454 SOUTH AFRICA -8.741

In Summary: Over the period 1991-2016 On average real deposit interest rates were positive for most African countries On average real deposit interest rates of most African countries were higher than in the US Uncovered Interest rate parity does not hold and the differential is in favor of African countries i.e. it is better to invest in Africa than in the US  The empirical evidence does not support the hypothesis that African invest abroad for economic motives.

Thank you.