Project development,

feasibility and
evaluation.
SUBJECT:
NEGATIVE INTEREST RATE

NEGATIVE INTEREST RATE:

DEFINITION:
A negative interest rate is in effect when the interest rate drops below
zero percent for a specific economic zone, meaning banks and other
financial firms would have to pay to keep their excess reserves stored
at the central bank rather than receive positive interest income.

HOW DOES NEGATIVE INTEREST RATE WORKS:

Under a negative rate policy, financial institutions are required to pay
interest for parking excess reserves with the central bank. That is, any
surplus cash beyond that which regulators say banks must keep on
hand. That way, central banks penalize financial institutions for holding
on to cash in the hope of prompting them to boost lending to
businesses and consumers.

REASONS FOR NEGATIVE INTEREST RATES:

Negative interest rates may occur during deflationary periods when
people and businesses hold too much money instead of spending. This
can result in a sharp decline in demand, and send prices even lower.
Often, a loose monetary policy is used to deal with this type of
situation. However, with strong signs of deflation still a factor, simply
cutting the central bank's interest rate to zero may not be sufficient
enough to stimulate growth in credit and lending. A negative real
interest rate means that inflation is higher than interest rates.
Therefore, savers will see a fall in the real value of their savings. ...
(basically , income effect is outweighing substitution effect) People feel
they need to save more because of the low-interest payments on
savings.
WHERE DID NEGATIVE INTEREST RATE COME
FROM?
The European Central Bank cut rates below zero for the first time in
2014 in response to the region’s dire debt crisis and dangerously low
inflation following the 2008 financial crisis. Several countries across
Europe, including Sweden, Denmark, and Switzerland, followed in the
ECB’s footsteps and lowered rates below zero shortly after. 

The Bank of Japan adopted negative rates in 2016, setting short-term

borrowing costs at -0.10% and buying huge amounts of government
bonds in the open market to lower long-term yields. The process of a
central bank buying long-term bonds is known as quantitative easing,
and it often puts downward pressure on bond yields. 

Negative rates at the time were seen as short-term jolts to struggling

economies, but the phenomenon has slowly evolved into something
analysts and investors are prepared to grapple with for the long term.

COUNTRIES WITH NEGATIVE INTEREST RATE:

Following are some countries with negative interest rates:

 JAPAN: (-0.10%)
Money was already cheap in Japan, and negative rates have succeeded
in making it even cheaper. Another reason is to vanish deflation yet
deflation has not vanished. Nor has there been an explosion of new
bank lending, as businesses say they can’t find enough profitable uses
for funding, even if the money is cheap.
  SWEDEN: (-0.30%)
On 2 July 2009, Sweden's bank was the first central bank in the
world to implement a negative interest rate, when it lowered its
repo rate (the rate at which a central bank lends short-term
money to commercial banks against securities) to 0.25%.

 SWITZERLAND: (-0.80%)
The Swiss government ran a de facto negative interest rate regime in
the early 1970s to counter its currency appreciation due to investors
fleeing inflation in other parts of the world

 DENMARK: (-0.70%)
In Denmark, the ultra-low interest rate environment has in turn caused
home prices to increase as borrowers could afford pricier homes.

 BULGARIA: (-0.331%)
The purpose of the introduced negative interest rate on the excess
reserves of the banks in Bulgaria was, first, to transmit the
expansionary monetary stance of the ECB through the interest
rate transmission channel and second, the BNB to avoid potential
losses.

REASONS FOR USING NEGATIVE INTEREST RATES:

Negative interest rates are designed to:

i. Get banks lending-they will pay the central bank interest for
holding money on deposits with them.
ii. Bring about reduction in real interest rates which might in turn
stimulate increased business investment.
iii. Negatives rate are partly designed to outflow hot money thereby
depreciating the exchange rate.
iv. Main aim of negative rates is to lower the risks to output, profits,
employment and wages from deflation.

RISKS FROM NEGATIVE INTEREST RATES:

i. Negative interest rates can lower bank profitability by narrowing
the interest rate margins between saving and loan rates- this is a
threat to their long run stability.
ii. Negative rate can also banks to take excessive risks in search of
higher returns -leading to asset bubbles including the housing
market (another housing boom?).
iii. Lower interest rates on deposits may cause households and
businesses to hoard cash rather than spend/invest.
iv. Pension and insurance companies may struggle to meet their long
term liabilities if long term interest rates (yields) are close to zero
or below.
v. Economy may become dependent on ultra-low interest rates
whereas expansionary fiscal policy might be more effective in
stimulating real investment and growth.