You are on page 1of 2

What is the impact of Negative Interest on Growth and Should India also seek an experiment with

negative interest rates?

Negative interest rate is a tool of modern economics, which go hand in hand with other expansionary
monetary or fiscal policies followed by Central bank or Central Government. The very purpose of negative
interest rate is to boost credit circulation in the market and drive down cost of borrowing, thereby increasing
market activity. Negative interest rates are always considered to be the last resort of central bank and are now
always frequently used in larger economies.

In a negative interest rate environment, target interest rates are set as negative. This means that instead to
receiving interest for deposits, depositors would need to pay interest to keep the money at the bank. On the
other hand, borrowing of money would be almost cost less, rather, beneficial for borrowers. The private banks
also face the same dilemma as they would need to pay interest if they keep money with their central bank, but
would get interest if they borrow. Thus private banks also try to lend out as much as possible, subject to the
guidelines issued by the Central Bank or Government. This vicious cycle helps in creating and maintaining
liquidity in the economy to boost economic activity.

Although negative interest might look a great tool for policy makers, it has a downside too, known as
Liquidity Trap. The negative interest discussed above is the real interest rate (which is calculated as, Real
Interest Rate = Nominal Interest rate Inflation Rate). Policy makers can make real interest rate negative, but
not the nominal interest rate. So they can reduce nominal interest rate only till zero. Real interest rate would
not go down any further.

Negative interest rate has been widely used in many European countries recently and also in Japan. While
majority of smaller economies or Europe has used negative interest rates to make their capital market less
attractive. This helps them to supress the demand of their economy, which in turn weakens the currency of
their country. This helps in increased exports and higher economic activity for them. Denmark and
Switzerland are leading examples of such policy decisions. They have repeatedly reduced their interest rates
to reduce the attractiveness of their investments to the foreign world.
Although European countries like, Denmark and Switzerland have used Negative Interest Rate Policy for
currency price stabilization, it has been the object of Japan for fairly long term. Japan has been using the
policy of negative interest rate throughout this decade. Japan has also been facing deflation since long, which
has translated into slower economic growth over the years. Thus japan uses the negative interest rates to boost
the activity in the economy and cause artificial inflation. Their policy revolves around the target set by the
Central Bank of 2% annual inflation rate.

In Indian context, recent economic turmoil has decreased Indias output growth by some margin and has
slowed down the growth. De-monetization has negatively affected the economic activity in the economy,
majorly in the unorganised sector. Also, due to imposition of GST, the economic activity of unorganised and
small to medium sectors has affected negatively again. These sectors cover the majority of Indian economy,
both in terms of value addition and also employment generation.

Using negative interest rates in India would translate into better availability of credit and lower cost of
borrowing. The huge savings of the nation would be channelized in a more productive way. This would
positively impact the investments and consumption. Companies would be able to focus on capacity building
and real estate investment would increase multiple folds too. This would indirectly mean higher income for
consumer and thus more consumer spending, which in turn generate higher demand in the economy for foods
and services. Lower Interest rates coupled with semi-restricted capital market of India would mean a
strengthening of Indian currency. This would translate into cheaper price of foreign goods for Indian
consumers. So imports in the economy would rise. But rise in exports due to higher domestic production
would be offset by rising Indian Rupee in the international market. So export would rather be constant.

Negative interest rate is only used when nominal interest rates and inflation are almost equal. After that
situation, to reduce interest rate further, a country needs to employ negative interest rates. Although, negative
interest rate might lead to boom in economy by higher production and consumption, this would also lead to
increase in price levels. In short term, the effect of increase in income is not spread evenly throughout the
economy and a big portion of population, especially in India, who are away from mainstream economic
activity, would have to bear higher prices, without being compensated by rise in income.
Also, India being a developing country has very high nominal interest rates compared to other countries that
employ negative interest rates. Recently the inflation in India has come down and has stabilized also. This
gives the central bank enough room to decrease interest rates without being forced to make it negative. In a
developing economy like India, where inflation and development both are a primary concern, should not take
such extreme steps to employ the negative interest rate policy at this moment.

References:

Credit Suisse. 2017. The Effects of Negative Interest Rate Policies - Credit Suisse.
https://www.credit-suisse.com/corporate/en/articles/news-and-expertise/the-effects-of-negative-
interest-rate-policies-201703.html.
BBC News. 2017. Why use negative interest rates? - BBC News.
http://www.bbc.com/news/business-32284393.
http://web.mit.edu/krugman/www/trioshrt.html