Poor interest rate

Friday, January 27, 2012

Dear Editor,

The prevailing perception among many (a perception indelibly impressed upon the minds of my compatriots by the media and the private sector) that a low interest rate is desirable, whereas a high interest rate is bad, is a disposition that needs to be debunked.

The truth is that no economy in the entire world - be it USA or China - has ever set out to achieve a certain level of interest rate as an end goal. These economies, formidable as they are, view interest rates simply as an impetus to stimulate or reduce the rate of consumption/ investment, whichever the need may be.

In order to gain a scuba diver's insight into understanding the interest rate, it is indispensable to know the variables that help to determine it.

These variables are inflation, supply and demand of money, and default risk.

Under normal circumstances, inflation and interest rate move in tandem with each other, with the interest rate pacing ahead. However, in the post-JDX era, the interest rate took a nosedive to its present low of 6.25 per cent. At present, inflation for the calendar year is six per cent. This left savers with a .25 per cent real return on their savings.

This is simply not enough to convince me to purchase GOJ bonds, especially after the sacrifice I made with JDX.

Since interest is the price one pays for borrowing money, it will rise as the demand for money increases relative to the money supply. Because of the meagre real rate of return, savers are not induced to save. This lack of saving is putting a strain on the money supply. On the other hand, government is heading to the domestic capital market to satisfy its appetite for money as funds from international institutions cease to come.

Default risk is the likelihood that the borrower (GOJ) may not be able to repay it debt. As the probability of this increases, the interest rate will rise too. The rising debt-to-GDP ratio, the falling-off of collected tax revenue and the yawning budget deficit which continues to widen are ominous signs of Jamaica's shrinking capacity to honour its debt obligations.

The interest rate remains stubbornly defiant of all indicators, but there is a lesson to be learnt. The argument that low interest rates will bolster economic growth is not necessarily true. And the record of the last fours year has proved this.

So now, while the indicators are pointing north, interest rates are trending south, and the private sector is at a crossroads, not knowing where to turn!

Oniel Edwards

oniel_rohan@yahoo.com