The Low Level of Interest rates

Less than one month ago, Star Knitwear, was seen to have accumulated such a large amount of debt that it sank under the weight of the debt, the low interest rate regime over all these years notwithstanding. The question is whether efficient management of an enterprise and its resources is more important than the level of the interest rate at which a company borrows funds from financial institutions

Many will still recall the epic fights former Governor of the Bank of Mauritius (BoM), Manou Bheenick, waged for long in the Monetary Policy Committee (MPC) to lift up our interest rate structure.

Since he kept losing, being outnumbered in the MPC, the perception was created in the public that his stand would be wrong.

That need not necessarily be the case. He was putting up the fight from the point of view of numerous savers who he believed were being unduly lowly remunerated. He was also concerned that a prolonged suppression of interest paid on savings would act against growth of investment by encouraging excessive consumption while also leaving little behind for a rainy day. He was in fact pleading for creating additional economic capacity in the country. This went unheeded.

He was also right inasmuch as Mauritians, especially a lot of them at the lower end of the economic ladder, gradually got increasingly indebted. The indebtedness was no longer solely for people acquiring “capital” goods, such as a house, motor vehicle and furniture as it used to be the case before. Increasingly, people were scaling up their indebtedness for hire purchase of consumption items, including taking on debt for foreign travels.

Interest rates remain depressed until today as far as savers are concerned. On the other hand, borrowers have been having it too good over a number of years since at least 2006. The MPC often took the view that, as economic conditions were still depressed and the rate of inflation relatively low, there was no reason to move interest rates up. It believed that industry could not sustain a higher cost of borrowing.

Besides, the MPC argued, the international economic outlook was gloomy and any hike in domestic interest rates would thwart economic progress. Low interest rates encourage not only households to get into excessive debt; they also push enterprises to borrow the more while diverting their own funds to other personal uses.

Less than one month ago, a long-standing textile unit in the north, Star Knitwear, was seen to have accumulated such a large amount of debt that it sank under the weight of the debt, the low interest rate regime over all these years notwithstanding. The question is whether efficient management of an enterprise and its resources is more important than the level of the interest rate at which a company borrows funds from financial institutions.

In the last MPC, it was decided to maintain the BoM’s Key Repo Rate, the reference rate for all other interest rates in the country, at its pre-existing level of 4.65%.

Meantime, commercial banks, finding it difficult to employ their liquidity fully, have recently taken to bringing down the interest rate they pay on savers’ deposits, not minding the status quo maintained by the MPC at its last meeting. The question is whether expanding the scope of our economic activity – and hence employing the surplus funds lying idle in the banks productively by financing business — is not more important than playing on the level of the interest rate to induce economic growth.

Since Alan Greenspan of the US Federal Reserve Bank (US Fed) decided to bring down interest rates to very low levels in 2001, except for the few stimulating initial years after the low-interest rate policy was endorsed, economies in the West have not been faring well starting from the financial debacle of 2007. It need be recalled that interest rates have remained stuck at the very low end for 20 years now in Japan and for 6 years in the US, the UK and the euro-area with tepid or quite low rates of economic growth recorded.

Central banks in the West have therefore lately been considering whether the time had not come to edge up their interest rates. Thus, after a series of hesitations, the US Fed is thinking of raising the interest rate, albeit gradually, in a timeframe of 9 months. Similarly, the UK is considering a horizon of 10 months before starting hiking up the interest rate while the euro-area and Japan are thinking of doing the same in 34 and 72 months, respectively.

We in Mauritius have wrongly been considering all these past years that a low interest rate regime is a positive adjunct for economic growth. I hope there will be more like me who believe that it is by further diversifying the economic base of our country and by inducting ever newer sustainable export activities that we can make progress, not by constantly reducing the level of the interest rate in the country.

 

*  Published in print edition on 3 July 2015

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