The International Monetary Fund (IMF), has advised that while low rates are desirable for growth, extended periods of low rates will have a cynical effect on the economy just as seen in many advanced countries.
The body warned that a major downturn could result in a $19 trillion corporate debt default and the first to be likely affected will be pension funds life insurance companies that are taking on more risky investments to meet their return objectives.
In her “Curtain Raiser Speech”, Kristalina Georgieva, IMF’s newly-appointed Managing Director said that interest rates are already very low or even negative in many advanced economies since inflation is still subdued in many countries and overall growth is weakening.
“In our surveillance, we see such an increase of risk-taking by investors broadly around the globe. This creates financial vulnerabilities. In some countries, firms are using low rates and building up debt to fund mergers and acquisitions instead of investing.
“Our new analysis shows that if a major downturn occurs, corporate debt at risk of default would rise to $19 trillion, or nearly 40 percent of the total debt in eight major economies.
“This is above the levels seen during the financial crisis. Low-interest rates are also prompting investors to search for higher yields in emerging markets. This leaves many smaller economies exposed to a sudden reversal of capital flows.
“So we need macro-prudential tools. And we can use new approaches to better manage debt, reduce financial booms and busts, and contain volatility,” she said.
In the same vein, Georgieva said that the success of central banks all over the world will be dependent on their independence, advising that with regards to interest rates, bank staff must master clear communications, remain data-dependent and nimble when necessary.
She acknowledged that central banks around the world are working hard to achieve their mandates despite unfavorable conditions; hence their independence is the foundation of sound monetary policy.
“But we should state one thing very clearly. Monetary and financial policies cannot do the job alone. Fiscal policy must play a central role,” she said.
According to Georgieva, the right time has come for countries with room in their budgets to deploy fiscal firepower or be ready for it, adding that low-interest rates may give some policymakers additional money to spend, especially in infrastructure.
“That advice will not work everywhere. Globally, public debt is near record levels. So, in countries with a high debt-to-GDP ratio, fiscal restraint continues to be warranted.
“Countries will, of course, tailor policies that work for them. But in every country, reducing debts and deficits should always be done in a way that protects education, health, and jobs.
“And every country needs to wrestle with the question of where, in a rapidly changing world, new sources of growth will come from. I believe focusing on fundamentals can help.
“One way to create more fiscal space is through domestic revenue mobilization. Reducing corruption and utilizing digital tools in tax collection can unlock resources and fuel new investments in people. It can also help countries reach the 2030 Sustainable Development Goals,” she added.