Impact of Negative Interest Rate

By Payal Sachdeva

The concept of “Negative interest rate” was flourished after 2008 financial crisis when all other means to reinvigorate the economy had been exhausted. It is a monetary policy tool employed by central banks to combat deflation. This tool was first adopted by Sweden’s central bank in July 2009 when the overnight deposit rate was lowered to -0.25%. European Central bank did the same in 2014 followed by Bank of Japan recently which has resulted in $10 trillion worth of government debt carrying negative yield.

A common misconception with the concept is that the depositors think they need to pay interest for their deposits to the bank. However, this is not true. Usually, commercial banks are required to keep a certain amount of money as reserves at their central bank as a safeguard against bank runs and to accommodate for last minute loans. The central banks generally pay the interest rate on these deposits, however, in Japan and Eurozone, banks have to pay central banks for parking their reserves.

Since commercial banks are charged for parking their reserves with the central bank in negative interest rate regime, they prefer to park that money with other banks to manage liquidity and meet the reserve requirements at a lower rate with an intention to earn some interest. Since a lot of banks try to get rid of their excess reserves, the competition pushes the interbank rate down which enables banks to pass on the benefits to their customers in the form of lower mortgage, personal loan, education loan etc. This is the ultimate objective of lower interest rate – to encourage investment and consumption, thereby stimulating the economy. Also, it might encourage investors to seek avenues abroad for better returns, which eventually leads to the depreciation of the currency due to the currency outflow. This would in turn boost exports to revive the economy. Euro has depreciated against the dollar by 20% since ECB introduced negative deposit rate.

However, a major concern is that banks would be unwilling to increase the lending as the profit margin between lending and deposit rate squeezes when they absorb the cost of negative interest rate. Though central bankers say it’s too early to gauge the impact of interest rate, they predict that if more and more central banks use this tool, it could actually lead to a currency war of devaluations.

Argentina’s Return to International Credit Markets

By- Monica V

After 15 years of exile from the international credit markets, on 19th April, Argentina made a bond issue of $16.5bn, the largest ever for an emerging-market nation. Out of $16.5bn, $9.4 billion of the proceeds were used to pay off the holdout bondholders on 22nd April, and the remaining $7.1 billion has been earmarked for infrastructure development.

Moody’s Investors Service (“Moody’s”) has upgraded the rating of the sovereign bond issue to B3. The bonds were issued with maturities of 3 to 30 years, at yields ranging from 6.25 percent to 8 percent, much below average for similarly rated countries. This could be attributed to the positive outlook for Argentina, as a result of President Macri’s business friendly administration, which has pushed through several economic reforms, such as floating the peso to make exports more competitive, and cutting back subsidies of electricity, water, gas and transport.

Hence, there has been a robust demand for Argentina’s bonds, despite its economic woes, with inflation at 35%, unemployment at 12%, its largest trading partner, Brazil, being in deep recession, and its troubled history as a borrower, having defaulted 8 times since independence. The issue had a blockbuster reception, attracting orders of $69bn for its $16.5bn bond sale. Furthermore, the robust demand pushed down the yield allowing investors to make $597 million in profit in just two days. US investors took 66% of the sale, Europeans 25%, the Middle Easterners 5%, and Latin Americans 4%.

Argentina’s return to international credit markets will curtail reliance on central bank finances, thus, helping to reduce inflation and boost growth. Furthermore, the bonds may be included in the influential JPMorgan index of emerging market bonds. While, Macri has said that it could take time to reap the benefits, the Minister of the Economy, Alfonso, explains that this step will establish the base for more jobs, and the road to zero poverty in Argentina.

Grexit vs. Brexit

By- Amrita Dubey

Grexit has been widely debated in the past few years. But the latest acronym to have entered the economic discourse in the last one year is Brexit. Grexit is referred to the potential Greek exit from the Eurozone, while Brexit is the prospect of the United Kingdom leaving the European Union.

Grexit Although Grexit seemed a very probable event last summer, the idea has lost merit over time. The notion that a Greece exit could pave the way for other

Although Grexit seemed a very probable event last summer, the idea has lost merit over time. The notion that a Greece exit could pave the way for other debt-burdened states like Portugal, Spain to reject the path of austerity  forced the authorities in Brussels to issue a third bailout for Greece

The Greeks were caught between a rock and a hard place. With the strong Euro, they couldn’t export their way out of a crisis as other nations in the past had done. But leaving the Euro would be accompanied by a period of uncertainty which could have led to further economic hardships for the Greek public.


It arose because of PM Cameron’s election promise to conduct a referendum on whether the UK should leave the EU or not. Supported by the political right and opposed by the political left on both sides of the Atlantic, it has sharply divided opinion among the British people. Proponents feel that Britain has been held back by the EU on account of red tapes and want to have more control over its borders to reduce the number of migrants coming into the country for work. The opposition believes that leaving the EU would lead to lower growth, impact investments and exports and in general increase risk to financial stability.


Since there has not been any precedent of such exits, there are a lot of uncertainties over what would really happen if Grexit and Brexit were to come true. Although both the events might not materialize but the fact that more and more people are questioning the concept of the EU does not augur well for the future of Union.


By Astha Mehta & Nayan Saraf

Edited by Sachit Modi


Since the inception of the financial market, the interest rate has had a significant impact on various financial assets. The direct impact can be seen on the bond prices, which have an inverse relation with the interest rates. It also affects the deposit and lending pattern in the sense that with the fall in interest rates, the deposits decreases while the lending increases and vice-versa.

However, the impact is not just limited to the change in the saving and investment behavior of the individuals and bonds, but also extends to the valuation of various financial assets like stock prices, currency, real estate etc. This can be explained using the Gordon’s Model. The modelasset1 explains the valuation of an enterprise by discounted cash flow method. For example, any firm giving regular dividends, say $100, will have different values for different interest rates. When the interest rate (r) is low, say 1%, the value of the firm is, 100/r, i.e. $10,000. But as the interest rate goes on increasing to 25%, the value of the firm exponentially declines to $400. This is one of the reasons why in the low-interest rate regimes, the price of assets are high and vice versa. This is shown in Figure 1.

Similarly, the currency value is also influenced by the interest rates. Although, there are various factors affecting exchange rate, like economic stability, domestic good’s demand etc., but interest rate has a significant effect on the appreciation and depreciation of the currency. A decrease in interest rate is unattractive for foreign investors resulting in shifting of foreign investments to other countries with relatively higher returns. This weakens the domestic currency. As currency loses value, investors look for other investment sources like gold and real estate. Thus, the effect percolates down to these assets also.

These changes in the value of the assets cause investors to modify their portfolio holdings. There have been instances throughout history where the change in the interest rate has driven investors to alter their portfolio in such a way that asset bubbles were created. Now let’s look at some of the major asset bubbles which stirred the global economy.

U.S. Housing Bubble

The U.S. housing bubble is a perfect example where the lower interest rate was one of the key reasons to inflate the housing prices. The lower interest rate had given the opportunity to the investor to buy the house when the money was virtually freeasset2. The common explanation for the lower interest rate goes back to the hypothesis of “Global Saving Glut” by Ben Bernanke, Ex Fed Chairman. According to Ben, prior to the housing bubble, there was an excessive saving generated in the emerging market which was channelized to the U.S. market, and subsequently lowered the long-term real interest rates. He argued that a shortage of safe assets could also have contributed to the problem.

This fact could have been evident from the yield of 10Y U.S. Government bond, where the lower real interest rate has reduced the bond  yield from a high of 8% in 1995 to as low as 4% before the housing bubble (Figure 2).

Now this lower bond yield had caused the investors to shift to other risky investments. And real estate seemed to be an ideal choice for the investors then. During the post dot-com bubble era, the effective Federal Fund Rate was reduced dramatically from 6.5% to just 1%. This long-term lower interest rate had resulted in the dramatic increase in the asset prices (Housing). By 2006, this interest rate was normalized from 1% to 5.25% and people started regretting the exorbitant prices they paid for the assets which were overvalued. It brought about lower demand and increased monthly payments for adjustable rate mortgages. Soon after that, a series of defaults started, resulting in the bursting of the bubble. Figure 3 explains the same.


However, it is not completely true that the lower interest rate was the only reason which created this bubble. As Raghuram Rajan argued in his book, “Fault Lines”, that if there are other factors that encourage investment in a single asset, then the impact is amplified to an extent that asset bubbles are created. 2 This phenomenon was clearly evident in the housing bubble of 2007 when not only interest rate but also government policies like home buyer’s credit, easy lending practices, Fed’s focus on job creation rather than output, inefficiency of credit agencies etc. were equally culpable for it.

Japan’s Real estate bubble

A similar scenario can be seen in Japan’s real estate bubble. The Japan asset bubble started when US dollar depreciated against the yen due to the signing of the Plaza Accord by the US with Germany, England, France and Japan. The dollar depreciation boosted US exports, but at the same time made investors shift investments from the US to Japan due to foreign exchange fluctuations.

The rising value of yen hindered business opportunities for Japanese exporters. To protect its export market, Bank of Japan resorted to monetary easing by lowering the interest rates from 5 percent in 1985 to 2.5 percent in the early 1987. The free lending by Japanese banks increased the real estate and stock purchases which inflated the value of land and stocks. During this period, Nikkei tripled to 39,000 and real estate prices reached a record high. It was even rumoured that during this phase the Tokyo Imperial Palace was worth more than the entire state of California. The price rise continued for four years, until 1989, when BOJ finally increased interest rates on account of inflationary pressures, and caused the asset bubble to burst.

The Nikkei plunged from 39,000 to 20,000 in 1990 and retail loans became NPAs which resulted in the Japanese government to take twenty years to recover back to the pre bubble economy which is now commonly referred as the lost two decades.

The Japan debt crisis was also a result of lower interest rates. Lower interest rates allow governments to fund its economic spending through cheap debt. A part of government’s revenue is used to pay interest on the debt taken. When interest rates are kept low for a long period, the government’s borrowing increases and so does the interest payments. Later on, if there is an increase in the interest rate, the interest payment shoots up consuming a large part of or sometimes whole of the government’s revenue. This creates a vicious debt trap.

Shale oil production bubble

Shale oil production is another case where the low-interest rate had fuelled the gas drilling bubble. Since the crisis of 2007, Fed had kept the interest rates constant, nearly zero, which resulted in loose money being poured into the capital intensive oil drilling process for years. When these investments became successful, there was an excess supply of oil in the world economy. Since, in just a period of one year, the price of oil plummeted from $120 a barrel to just $30 a barrel, the shale oil production (drilling industry) busted.

There are more than 50 shale oil production companies in the U.S. and more than half of them have already filed for bankruptcy due to the plunging oil prices. None of these oil companies are able to reach the break-even point. And the ones who haven’t filed for bankruptcy are running in huge losses.

Now, the Fed has again increased the interest rate by 0.25 basisasset6 points and it would have negative consequences for these oil companies. Firstly, it would lead to an additional debt cost in their balance sheets. Figure 6 clearly indicates there is an increase in debt due to cheap lending and also, the increase in debt to gross cash flow, due to lower generation of cash flow from the operations. Second, the higher interest rate will increase the cost of capital, which would mean that these stressed drill companies would lose access to finance. Third, the higher interest rate will result in the appreciation of the dollar, leading to downward pressure on oil prices, due to crude oil being priced in dollars.


Central Banks undertake monetary easing often by lowering interest rates, in order to stimulate the economy, but more often than not, end up in creating an asset bubble. The various historic events highlight the role that interest rates have played in the financial market and its effect on the asset prices.

Even though, these events indicate that various factors contributed to the loss of wealth due to bubble formation, investors sometimes ignore the risk and fall into the trap of increasing asset prices. It is also noteworthy that the dot-com bubble burst after the Fed had increased the interest rate by 1.91% in 1999-2000. More interestingly, the current US housing index shows that the US house prices have reached to new heights while the interest rates are nearly zero. So, are we heading for another bubble? Well, it is difficult to predict as of now, but it would be interesting to see what happens to the housing prices when Fed would further increase the interest rates.


astha_tjef1About authors:

The author is a Banking and Financial Service student of batch 2015-17 at TAPMI. Her area of interest  includes economics, banking, data analysis and digitalisation. She is also a senior analyst at Samnidhy. You can contact her at

The author is a Banking and Financial Service student of batch 2015-17 at TAPMI. His area of interest is mainly economics, banking, and risk management. He previously submitted his research paper on REGRESSIVE EXCHANGE RATE POLICY OF CHINA. He is on the editorial board of TJEF and also the member of Literary and Media Committee of TAPMI. You can contact him at