Decades of global gains can be wiped out as prolonged low interest rates threaten recovery, warns Tharman

Decades of global gains can be wiped out as prolonged low interest rates threaten recovery, warns Tharman

People’s Action Party’s (PAP) senior politician and MP Tharman Shanmugaratnam pointed out that keeping low interest rates to deal with economic slowdown due to COVID-19 pandemic is not an effective or sustainable long-term solution.

Speaking in a virtual panel organised by DBS Bank as part of its two-day Asian Insight Conference, Mr Shanmugaratnam cautioned against the impact on retirement funds and economic recovery globally.

He added that there is also “a very real risk of a submerging world” as decades of worldwide economic growth, contributed by the growth of emerging economies like China, could be wiped out by the fallout from the pandemic.

“The strategy of an extended period of very low or negative interest rates, as (far) as a significant payoff in terms of corporate investment goes, just hasn’t been very effective or efficient,” he said at the conference on Thursday (23 July).

The one-hour virtual conference was moderated by DBS chief economist Taimur Baig, and along with the PAP’s member, the panel also consisted of former International Monetary Fund (IMF) economist Raghuram G Rajan.

Generally, cuts on United States Federal Reserved (Fed rate) has an impact on interest rates all around the world, including in Singapore. The Singapore Interbank Offered Rate (SIBOR), in which interest rates are pegged, is linked closely to global money markets. This is why when the Fed cut happened in the US in March, the one-month SIBOR has dipped to about 0.25 percent, a decrease from above 1.5 percent before the pandemic.

When asked on the possibility of continuous low interest rate environment, Mr Tharman said: “We’ve gone through an extended period — almost uninterrupted since the (2008) global financial crisis — of extremely low interest rates and substantial amounts of liquidity flowing around the system. You don’t need to be an economist to say this has contributed to much higher levels of corporate leverage (using borrowed money to invest).”

By lowering interest rates, it makes it less expensive for businesses to lend money, which is helpful during a crisis as it helps to spur investments and spending. Many central banks around the world have cut their interest rates to historic lows due to the global financial crisis and the rates have remained at near record lows ever since.

Risk increases with low interest rates

Although Mr Tharman said that lowering interest rates “is the right thing to do in the midst of a crisis”, but prolonging such a strategy did not benefit in spurring corporate investment significantly since the global financial crisis in 2008.

In fact, Mr Tharman, who is also Monetary Authority of Singapore chairman, said that it resulted in investors’ money channelled into higher risk investments or “in an indiscriminate fashion” into emerging markets in order to look for higher yields amid the low interest rate environment.

“We entered this crisis with a lot of risk in the system already, and a fair amount of that risk was the consequence of well-meaning central banks suppressing risk premia and encouraging people to go on a search for yield by looking for more and more risks,” Mr Tharman noted.

Echoing the same sentiment, Professor Raghuram also stated that when a pandemic occurs, investors began pulling out of emerging markets until the Fed cut its rates in March, and money started going back in.

“If we have more blows to come, which is still an area of uncertainty, then perhaps what (the Fed) have done is just to stave off the moment… acting as a palliative rather than a solution,” he explained.

Additionally, pension funds and retirement savings around the world will also be affected due to lowering interest rates, said Mr Tharman.

When there is a possibility of retirement and pension funds dropping, this will lead to people saving more money and spending less.

“That’s the natural reaction. And when you save more, you’re consuming less, and that becomes a dampener to growth as well. So that’s another reason why one has to be a little sceptical about the effectiveness of this strategy in promoting growth,” he said.

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