Md. Harun-Or-Rashid :
Economy of a country principally depends on interest rate, and is one of the strongest tools at the disposal of a central bank. Central bank sets a target interest rate and accepts deposits or loans out money in an effort to influence market rates, forming an important part of monetary policy. Low interest rates always sound superior, but in reality, they can pull down the economy, and are considered to be prognostic indicators of economic crisis. During low interest rate periods, funds and banks are tempted to invest in low-quality credits to meet their income needs, but during high interest rate periods they can lock in high investment and loan income by extending their maturities as far as possible. For example, if a bank earns lower earnings due to lower interest rate it will declare lower dividend to investors which will impact on the stock market negatively and subsequently international rating of the bank will be lower as banks earn lower comparative to previous year which will increase reimbursement charges. Also, negatively impacts on government revenue collection which may augment government borrowing and increase national debt.
As such, low interest rate can reduce overall investments which can significantly reduce overall growth of the economy. Conversely, lower interest rates make funds cheaper to borrow which tends to encourage spending and investing (subject to banks willingness to new disbursement of fund, it is assumes that new disbursement will be low as 9% interest rate is challenging to sustain in consideration with cost of fund, classified loan, overhead cost, regulatory issue etc). Lower interest rates are bad news for savers. For example, retired people may live on their savings. If interest rates fall, they have lower disposable income and so will probably spend less. If a country has a high proportion of savers then lower interest rates will actually reduce the income of many people as savers will receive a smaller return from savings. On the one hand, lower interest rates encourage consumer spending; therefore there will be a rise in spending on imports. This will cause worsening in the current account. However, lower interest rates should cause depreciation in the exchange rate. This makes exports more competitive, and if demand is relatively elastic, the impact of a lower exchange rate should cause an improvement in the current account and lead to higher aggregate demand (AD) and economic growth and may also cause inflationary pressures. . A fall in the exchange rate makes BD exports more competitive and imports more expensive. This also helps to increase aggregate demand. In general, lower interest rates should cause a rise in Aggregate Demand (AD) =C (Consumption) + I (Investment) + G (Government Spending) + X (Exports) -M (Imports).
A fall in interest rates will reduce the monthly cost of mortgage repayments. This will leave householders with more disposable income and should cause a rise in consumer spending. Lower interest rates make it more attractive to buy assets such as housing. This will cause a rise in real estate pricing and therefore rise in wealth. Increased wealth will also encourage consumer spending as confidence will be higher.
Also, lean to cause a rise in asset prices and the cost of living and at the same time, lowering the return on fixed-income investments that provide income for retired individuals, foundations and other entities reliant on bond interest for income. Banks, insurance companies, pension funds, retirees, charitable foundations and educational endowments; all have income targets they must meet using returns on fixed-income investments or loaned money. If they can’t meet those requirements, they must cut back their spending or, if applicable, raise their fees. Alternatively, banks can lower their lending requirements and make larger loans to borrowers with poor credit, who expect to pay considerably more than prime rate for their money. Every investor has a level of risk that is acceptable, and that level is comprised of the potential returns against potential losses. It makes sense to put money into bonds, savings accounts and certificate of deposits if interest rates are high. However, when interest rates are low, that money will not earn as much. If the inflation rate is higher than the rate of return on the investment, it is losing real value.
However, high interest rates can eat into companies’ earnings through higher interest payments, or lead to dull growth due to slower expansion. When BB increases its discount rate, it has a ripple effect in the economy, indirectly affecting the stock market. Investors should keep in mind that the stock market’s reaction to interest rates is generally immediate, whereas the economy takes time to see any widespread effect. The banking sector benefits from higher interest rates because it can boost profits by charging more for credit products. The stock market doesn’t generally like high interest rates. High interest rates can increase costs for companies across a wide range of measures. Increased costs can result in lower profits and subsequently lower stock prices. However, gradually rising interest rates might actually be beneficial for the stock market, as they may reflect positive trends in the underlying economy. Interest rates can indirectly affect stock market prices by increasing the cost of borrowing for companies.
High interest payments on the national debt pose a considerable threat to the economy. As the national debt rises, government borrows, issuing both short-term and long-term securities. When treasury notes and bonds mature, they are rolled over to new notes and bonds at the prevailing rates. As long as rates remain low the interest payments remain manageable. But if interest rates rise, debt service will grow; both in absolute terms and as a percentage of the government budget.
However, market rate of demand and supply will be determined by the market itself. Interest rate can foster competition, reduce risk perception, overhead costs, and cost of funds. Consumer protection and financial literacy measures are also important measures, especially if interest rates are meant to protect consumers from usury rates. During a recession, the government may lower interest rates significantly to encourage businesses to borrow and consumers to spend more money. But lowering interest rates can have some negative consequences as well, including poor returns on savings which may not offset the inflationary effects.
(Md. Harun-Or-Rashid, Works at Social Islami Bank Limited (SIBL) as Manager Operation, BBA, MBA (Banking), DU, Certified Finance Specialist (CFS), Certified Project Management Analyst (CPMA).)
