What Sub Zero Interest Rates Mean for the Economy

Penulis: Yura Syahrul

Editor: Yura Syahrul

18/2/2016, 08.25 WIB

Many developed countries have introduced sub zero interest rates because they are having such a hard time recharging economic growth. Indonesia is different.

Gedung pertumbuhan
Arief Kamaludin|KATADATA

KATADATA - On Tuesday (2/16), Japan shocked the world by adopting a sub zero interest rate policy. The eyes of economists and market players are now on Japan. If this works out for Japan, other major world economies like Canada and United States are bound to follow suit. Indonesia, as an emerging market country, will also be affected by this policy. 

Despite being raised during every global financial market dialogue in the last decade, only small regions like Scandinavia have adopted sub zero interest rates. Three years ago, Denmark introduced sub zero interest rates, closely followed at the end of 2014 by Switzerland, where the interest rate was set at minus 0.75 percent. This meant that instead of receiving interest, depositors at banks in those countries would have to pay 0.75 percent of their money deposits to the bank. 

This unusual policy started to attract global attention when the central bank of Sweden adopted a sub zero interest rate policy in February last year, because Sweden Riksbank, the Swedish national bank, is the world’s oldest central bank and main monetary authority. And last Thursday (2/11), the oldest bank in the world lowered interest rates further, from minus 0.35 percent to minus 0.50 percent. 

But most surprising of all was when the European Central Bank (ECB) and Japanese Central Bank followed suit . At the end of last year, ECB lowered its interest rate to minus 0.3 percent, and on 29 January this year, the central bank of Japan announced that it was moving into sub zero interest territory, starting at minus 0.1 percent, which applies to all banks that park funds in the central bank.

The main purpose of this policy is to depreciate the yen in order to boost exports, which in turn will trigger the growth of long-stagnant Japanese economy. An interest rate of minus 0.1 percent encourages depositors to spend, which will hoist the rate of inflation and make the economy more vibrant.

To boost a country’s economy, central banks are urged to cut their interest rate to boost investment and consumer spending. It is also useful to increase the value of stock exchange and other risky assets. And, by devaluating a country’s currency, export activities will be more competitive. Lastly, when a country cuts its interest rate, it will create expectations of a higher inflation rate in the future. 

Ever since a financial market crisis in the United States turned into an economic crisis in 2008, which spread to Europe, many countries have set their interest rate closer to zero. Because this failed to revive economies, sub zero interest rates were born. 

Damaging the financial system 

In an article in the New York Times, economist Neil Irwin explains that the global financial system was built on the assumption of positive interest rates. Which means that sub zero interest rates will damage financial and economic structures of a country. People will refuse to deposit their money in banks, causing losses to banks. 

When people no longer trust banks, people will put their funds in investments, sounding the death knell for productive business. This, in turn, will affect interest-rate based investments such as securities and mutual funds. Other financial institutions like insurance companies and pension funds will suffer because deposits and obligations are one way they circulate customers’ money. 

So, financial market analysts question the effectiveness of sub zero interest rates, only a few days into the policy in Japan. Eleven days after the announcement in Japan, the Nikkei index shed 8.5 percent, while the yen rose 6.5 percent against the US dollar. 

Concern on Japan’s stock exchange and financial market over spread to the global market. The stock prices of Japanese banks dropped 30 percent after the ratings agency Standard & Poor’s estimated a fall in bank operating profits of 8 to 15 percent. Also, yields on 10-year Japanese obligations will fall below zero percent. 

An economist at Mitsubishi UFJ Morgan Stanley Securities said the benefits to Japan from implementing this policy might be smaller than in the European countries, because the banks in Japan get 80 percent of their funds from customer deposits, unlike banks in Europe, which raise most of their funds on the capital markets.

What it Means for Indonesia 

Bambang Brodjonegoro, the Finance Minister, denied the possibility of Indonesia following in Japan’s footsteps. “The BI Rate is still 7.5 percent. Sub zero interest rates are a non-starter . The economy would descend into absolute chaos. This policy is only suited to the developed nations. No emerging market countries will implement that policy,” Bambang added. 

The minister also said that these countries had adopted this policy because their governments were having a hard time to boosting economic growth. Indonesia is different: here there is so much potential to boost economic growth. 

But, he added that this policy, when implemented in major developed countries, will certainly be of benefit to Indonesia. It is the perfect opportunity for Indonesia to seize the many foreign investors withdrawing from those countries. With a high interest rate and great economic potential, Indonesia is bound to be even more attractive to foreign investors. 

Founder of CRECO Research Institute, Raden Pardede, echoed Bambang’s words, saying that the government should use this opportunity to increase foreign direct investment (FDI) because they are the safest of investments and the best suited to help with the current account deficit. 

Reporter: Yura Syahrul Desy Setyowati

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