Effect of Financial Liberalisation of Interest Rates and Inflation Adjustments on the Economic Growth in Tanzania

Abstract

The main thrust of this thesis was to investigate the effect of interest rate liberalization policy and inflation adjustments on the economic growth of Tanzania. The relationship between interest rate liberalization and economic growth has attracted considerable amount of attention and discussions in recent years. McKinnon (1973) and Shaw (1973) developed hypothesis to test whether interest rate liberalization can lead to economic growth. Four research hypothesis were formulated to investigate the relationship between interest rates, inflation rates and economic growth and also compare the difference in economic growth before and after interest rate deregulation in Tanzania. Descriptive and correlation research was used to determine the relationship of the variables. The study used descriptive statistics (mean and standard deviation), regression model and Vector Error Correction Model to obtain coefficient of multiple determinant (R square ) to measure the linear relationship between variables, F value to determine if the regression analysis is significant and the significance P value to test likelihood of the null hypothesis being true. The results of the finding revealed that: there exist an inverse relationship between interest rates (lending rates) and economic growth, also the study found that inflation rate is a strong determinant of economic growth exerting an inverse relationship on the economic growth. Also the study found that there is positive relationship between deposit interest rates and economic growth. Therefore an increase in lending rates or inflation rate will decrease GDP of the country and retarding the growth of the real sector. Further there is long run relationship between interest rates and inflation on GDP. There is also a causal relationship running from interest rates and inflation adjustments to GDP. The study also analyzed the difference in economic growth before and after interest rate liberalization and found that there is a significant difference in growth after interest rate liberalization highlighting that Tanzania has benefitted as a result of financial liberalization. Theviii study findings are in line with the existing studies referred to in the literature review and economic theory. Based on the key findings and conclusion, the study recommended the following policy measures that would stimulate savings and encourage investments and contribute to the economic growth of Tanzania: The policy towards interest rate should be made as such savings is stimulated thereby increasing bank intensity to loan to investors seeking funds and also keep the lending rate at a reasonable rate to encourage borrowing and fund lucrative projects; Further, there is need to stabilize the performance of the financial system in Tanzania through political stability and embrace the spirit of good governance. With Agriculture being the economic backbone of the country with largest labour force, there is need to increase agriculture output by implementing the policies already in place like KILIMO KWANZA as this would reduce inflation and investments in other sectors such as Tourism and natural resources would also stimulate economic growth. While financial liberalization advocates for the freedom of the market forces in determining financial asset prices like interest rates there is need for the regulatory and supervisory framework for the financial sector to be enhanced to reduce the widening gap between lending rates and deposit rates as this would stabilize inflationary pressures