LOW INTEREST RATES IN A MULTI-SPEED WORLD

Executive Summary

Low interest rates are maintained to foster growth by increasing money supply in
the economy. The World Economic Outlook published by the IMF (International
Monetary Fund) in April 2016, suggests that the world economic growth has been slow
(2016 growth rate is 3.2%) and remains uncertain. Hence it is not a surprise that
many countries are trying to hold down interest rates. European countries such as
Sweden and Switzerland are in fact clocking negative interest rates.

Does this signify that keeping interest rates low can in fact boost the economy? If
we see Brazil on the other hand, in spite of poor GDP (-4.7% growth rate in 2015)
their interest rate is 14.25% (2016). Why does Brazil maintain such high interest
rates? It tells us that there are other factors involved. In the case of Brazil,
the inflation is so high that they are forced to maintain high rates to curb
inflation.

Apart from inflation and GDP there are other factors that affect and determine the
interest rates, such as, the type of economy based on the goods exported e.g., a
commodity driven economy like China. For China, the growth is affected by interest
rates set at countries that they export their commodities to. Whereas India is much
more immune to commodity prices as they are net importers of commodity (i.e.,
economy is not driven by commodity exports and drop in prices are welcome). On the
other hand maintaining low interest rates in India means depreciating the Indian
Rupee, thereby cancelling out the benefits of importing at lower prices.

We can see that the dynamics of various factors involved drive economic growth in a
multi-speed world. Lowering interest rate does not act as a magic wand to resolve
economic crisis. Prolonging low interest rates causes banks and financial
institutions to operate at lower margins. While in the short term, borrowing is
fuelled, in the long term investors are left with low returns. If we divide the
economy into Financial and Real sectors, we also need to look into reforms in the
Real sector. This means structural reforms the fundamentals of how the country
runs its businesses. This can include boosting employment, agriculture, banking
etc. The key lies in balancing Financial and Real sector reforms taking into
consideration global scenario.