- Aakriti Thakali
Ceteris paribus (when all other factors remain constant), the single purpose behind increasing interest rates is to curve the level of inflation. It is one of the major tool that any central bank uses in order to maintain financial stability in the economy. The basic logic behind it is, when banks provide higher interest rates, people will be inclined more towards saving than spending it immediately. So when people start to save rather than spend, the amount of money floating in the market declines which helps in stabilizing the inflation rate.
However as always there are always different theories to a single phenomenon. Some economists believe raising interest rates will help curb inflation, while some other believe that leaving interest rate out of leash can lead to hyperinflation. There are no significant mathematical proofs except past examples, as to which school of thought is right and because of that many economies apply different monetary policies to maintain stability and ensure desirable growth.
Where does Nepal stand?
As far as inflation is concerned we’re doing okay. As per the Monetary Policy published at the beginning of the fiscal year by Nepal Rastra Bank (NRB), the aim was to contain the inflation rate under 7.10%, against 9.9% of last year. So far, our inflation rate stands at 4% as of Poush, 2074. This is actually a good indicator that shows the effectiveness of NRB’s policies and responsiveness of our market.
Similarly, post devastating earthquake and blockade from India, we achieved a significant growth in GDP of 7.5% in the last fiscal year. However, this year things don’t seem to pick up the same way. The only stock exchange is still bearish, we are still heavily dependent on import and the export level has not improved much. To add in, for a past few months we are facing liquidity crunch in our market as a response to which the Banks and Financial Institutions (BFIs) are giving higher interest rates on deposits, both Savings and Fixed. To consider the recent examples we have
Kumari Bank and
Civil Bank. The primary motive behind this is to attract the little of money that is floating in the market in order to support the already disbursed credit commitment. However, unhealthy competition for scarce resource might bring catastrophic consequences, as a response to which NBA (Nepal Banker’s Association) has signed a Gentleman's Agreement to not increase the deposit rate of Saving and Fixed Deposits beyond 8% and 11% respectively. Following this agreement the above mentioned banks have decreased their interest rates within 2 days to the agreed standard.
What does this mean?
The Interest rate and Inflation rate of any economy are very crucial to determine if the growth they’re experiencing is sustainable or not, and the relationship between them although covert is understood by most. According to the officials at Nepal Rastra Bank, the agreement signed by the Banks is a good initiative to maintain market stability. However, in free market economy this might be considered as Syndicate. Whatever it may be called, Syndicate or Gentleman’s Agreement, the question we need to focus is on
“Is it good for us?”
Before answering that question, let’s look at the table below. It shows the interest rates and inflation rates of countries on either end of the extreme:
| S.N. |
Countries |
Inflation Rate (%) |
Interest Rate (%) |
| 1 |
Venezuela |
159.1 |
16 |
| 2 |
Ukraine |
49 |
15.25 |
| 3 |
Argentina |
27.6 |
23.7 |
| 4 |
Uzbekistan |
11 |
20 |
| 5 |
Myanmar |
8.9 |
10 |
| 6 |
India |
6.8 |
7.3 |
| 7 |
China |
5.4 |
2.5 |
| 8 |
Nepal |
4.5 |
6.21 |
| 9 |
Georgia |
4.1 |
10.4 |
| 10 |
United Kingdom |
2 |
1.9 |
| 11 |
USA |
1.5 |
2 |
| 12 |
Lithuania |
1.2 |
0 |
| 13 |
Japan |
0.4 |
0.10 |
*The interest rates are the average interest rates given out by commercial banks on deposits. The data of Nepal is taken from the Mid-term review done by NRB. Data for other countries are taken from various sources, however cross checks were done to ensure reliability and may represent an approximate figure.
The above table is made diverse in order to cover maximum variability among economies. Venezuela, currently in crisis, is facing hyperinflation and because of that a country sitting on oil mine is dying of hunger. Similarly Japan, a country with near zero inflation is successfully reporting its uninterrupted growth since 1980 on Q4 of last fiscal year. Like, we studied in our Economics class, a slight amount of inflation is always required for growth and to keep the investors motivated. But given the fact that Nepal is a developing country should we go for a more aggressive “Free Market Economy” outlook or appreciate the step taken by NBA?
Like we discussed in first para, higher interest rates lead to lower inflation rates. Theoretically, it makes sense but if we see the table above the countries with higher interest rates are also seen with higher inflation levels. In addition to that, if we see the context of our country NRB is strictly regulating the Banks and Financial Institutions (BFIs) in order to ensure optimum stability possible. With such interference, most often than not we can establish no relationship between Interest rates and Inflation rates.
The bottom line
Even after all this analysis and discussion, the bottom line to the big question is still subjective. However for a general saver, putting a leash on the interest rate is a good initiative. The competitive rise in interest rates might be exciting at first, even profitable to some. But the consequence of such unhealthy competition is always catastrophic. The major reason for the rise in interest rate is the liquidity crunch, but sooner or later the money spent on election will get back into the market, the government will start spending the budget allocated for development works and other disbursed funds will also be collected. Until then this Gentleman’s Agreement is expected to ensure safety of existing funds. And even if the situation gets dire than that, the government, finance ministry and NRB will take some measures to ease this deadlock.
