The world will have to live with high interest rates for now

Although the US and European Central Banks have signalled some relief by not raising interest rates in October, there seems to be a consensus in official circles and experts that there is no possibility of interest rates being dropping in the near future. This is because due to the Russia-Ukraine war in the past, there is no sign of decline in inflation in oil and food prices; and now due to the conflict between Israel and Palestine, the inflation situation may worsen further.

Although the European Central Bank has set a medium-term inflation target of 2.1 percent, this does not seem a rational projection in the prevailing circumstances. The inflation situation may worsen not only in the US and Europe but throughout the world.

From the point of view of interest rates, two types of countries were found in the world, one was those countries, where interest rates ranged between zero and a maximum of three percent and the other category was of countries where interest rates were found to be between six percent and 12 percent or even more. The first category included mostly developed countries, and the second category included mostly developing countries. But rising interest rates in developed countries have closed this gap.

Inflation-led Hike In Interest Rates

The policy interest rate is determined by the central bank of that country, like Reserve Bank of India in India, Federal Reserve in the US, Bank of England in England etc. But the determination of the interest rate at any time in a country is influenced by the rate of inflation.

The policy interest rate is generally called the bank rate. Apart from this, many other versions of it, like Repo Rate, Reverse Repo etc. are also announced, bearing different connotations. Broadly speaking, bank rate is the interest rate at which commercial banks of that country can borrow from the central bank.

These policy interest rates influence various types of interest rates in the country like interest rates on deposits, interest rates on borrowings etc. If the inflation rate is high and the interest rate is low, then people who have accumulated savings will suffer losses because the real value of their deposits will be depleted.

Therefore, according to the principles of economics, the policy interest rate should be higher than the inflation rate, so that the real rate of interest is positive, to give real return on deposits and encourage savers. For example, if the inflation rate is 6 percent, then to keep the real interest rate at 2 percent, the interest rate on deposits should be at least 8 percent. Therefore, as inflation increases, it becomes imperative to increase the policy interest rates.

Recession Knocking

On the one hand, there are no signs of inflation coming down, and fears of recession are increasing in countries around the world. Due to increase in interest rates, not only the demand for houses and cars can be affected, many other types of demand may also shrink. There is a possibility that the purchase of household goods will also be affected due to increase in interest rates on credit cards. While investment efforts in infrastructure, especially road infrastructure, were gaining momentum in the US, rising interest rates could depress that too. In such a situation, recession is knocking in these countries.

Developing countries are also not untouched by inflation and increase in interest rates. Both food inflation and fuel inflation are also affecting developing countries, due to which the inflation rate remains high there too. Therefore, the central banks of developing countries have also been continuously increasing the policy interest rates (Bank Rate, Repo Rate etc.). Among BRICS countries, this rate is 12.75 percent in Brazil, 8.25 percent in South Africa, 15 percent in Russia, 3.45 percent in China and 6.5 percent in India. Among other developing countries, it is 6.0 percent in Indonesia and 11.25 percent in Mexico.

Due to high inflation rates, there is no sign of reduction in interest rates in any major country. If we talk about India, today the inflation rate in India is 5.02 percent, hence the real interest rate still remains positive, whereas in many developed countries including America and European countries, the interest rate is lower than the inflation rate, and the real interest rate has become negative. This means that unless inflation cools down, interest rates in the US and Europe are unlikely to fall any time soon, though we can expect interest rates to cool in the near future in India.

India Least Impacted

It is true that India is also not untouched by global inflation, but still India is the least impacted in both fuel inflation and food inflation. The reason for this is that India has been successful in procuring cheap petroleum products from Russia despite the obstacles from USA and European countries. It is noteworthy that in recent times, India has been buying more than 50 times more oil from Russia than before. The price of this oil is also only 60 percent of international price and to a large extent it is being paid in rupees and not in dollars.

There is adequate production of food products in India, which is benefiting not only India but the whole world. Food inflation in India is much lower than many countries in the world. However, like other countries, disruptions in the supply chain are affecting India too. So while Indian inflation used to be much higher than that in the US and Europe in the past, last year it was much lower in India. For example, last year inflation in America was recorded at 8.2 percent, in Europe it was 9.9 percent, while in India the inflation rate was only 6.70 percent.

Perhaps this is the reason why in a world where recession is looming large, India has emerged as the fastest growing economy among the major economies of the world. India has been able to keep inflation under control due to the good performance of agriculture and allied activities and the protection of the country's economic interests due to its independent foreign policy.

We have to understand that by making our country self-reliant in every sector of the economy, minimising our dependence on foreign countries, especially in the supply chain, and moving forward with international relations on an equal footing with other countries, we will be able to take our economy forward regardless of the challenges facing the world. But it is also true that the world will have to learn to live with high interest rates for some time.

Ashwani Mahajan is a professor at PGDAV College, University of Delhi, and the national co-convener of the Swadeshi Jagran Manch. Views are personal, and do not represent the stand of this publication.