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16 September, 2019 00:00 00 AM
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Interest rate policy and its impact on business

Higher domestic interest rates lead to an appreciation of the exchange rate, and can reduce inflation by lowering the cost of imported items
Md. Harun Or Rashid
Interest rate policy and its impact on business

Economic influences such as interest rates can be a signal to either expand your business or pull it back. Once you understand the context for running your business, you can adjust to interest rate moves to protect yourself from negative effects and take advantages of positive ones. Interest rate changes brought about by government policy affect the borrowing cost of business. Increase in interest rates will mean that fewer investments show positive returns, deterring companies from borrowing to finance expansion. Increase in interest rates will also exercise a downward pressure on share prices, making it more difficult for companies to raise money from new share issues. Business will also be squeezed by decrease in consumer demand that result from increases in interest rates.

The interest percent is the amount charged by a lender i.e. a bank or a financial institution to a borrower for the use of assets, or the interest percent it pays a depositor when depositors keep money in a bank account. The purpose of interest rate is in response to money investment to look forward in narrowing the disagreement concerning the effects of cost and interest rates in the commercial banks.

What about the effects on the economy of a policy of high interest rates to reduce demand and inflation? Answer: An increase in interest rates is thought to reduce the money supply through demand for credit in the economy and thereby to reduce the level of effective demand which will decrease inflation and improve balance of payments (the balance of payments accounts of a country record the payments and receipts of the residents of the country in their transactions with residents of other countries and the payments and receipts of each country must be equal over a defined period of time i.e. a quarter or a year). It can also lowering the price of exports, increasing demand for them and simultaneously increasing the relative price of imports, reducing demand for them, and freeing more domestic output for sale abroad. Notably, a stronger Bangladeshi Taka makes BD exports less competitive; reducing exports and increasing imports. This has the effect of reducing aggregate demand in the economy.

Higher domestic interest rates lead to an appreciation of the exchange rate, and can reduce inflation by lowering the cost of imported items. Exporters will experience pressure on their costs as the result of the more competitive price conditions they face, and may be less willing to concede high wage demand, and wage inflation may be constrained. Remember, higher interest results in greater interest income for savers, who may increase their spending due to this interest premium. Since mortgage payments are generally a significant part of domestic household expenditure, any increase in them will be reflected immediately in reported inflation. This will have a significant impact on consumer spending. For example, if your mortgage payment will increase by 0.5 per cent in interest rates can increase the cost of a loan of BDT 10.00 Lac by BDT 417.00 per month. And it’s a significant impact on personal discretionary income (money you have left over from your post tax income after paying for necessary expenses like rent, utilities and food).

Higher interest rate could lead to higher wage demands in the economy, and may result in a wage price spiral. It also encourages capital inflows, and leads to an appreciation of the currency’s exchange rate, and makes exports more expensive and imports less expensive. A reduction in investment may decrease the pressure of demand in the economy but at the same time it will set in motion a process which in the future could reduce the economy’s potential for production. Finally, higher interest rates do squeeze demand in the economy which will reduce employment, and subsequently decreasing the proceeds of taxation and increasing government expenditures on the unemployed.

It also reduces investment expenditures mainly for two reasons: firstly, higher interest rates deter some investment due to increasing borrowing cost and secondly, may make the corporate sector pessimistic about future business prospects and confidence in the economy which may further reduce investments in the economy.

When interest rates rise, consumers with debts are going to have to pay more interest to lenders. This typically has a negative effect on their spending habits because the more money they have to pay to keep their loans, the less disposable income they will have to spend on products and services. For instance, if you own a business that deals in luxury products or services, you may be in a danger situation with upward interests rates than a company providing basic necessities, because luxury items are usually the first thing consumers eliminate when they have less disposable income. Therefore, other areas of consumption will also fall.

In most cases, every small business has outstanding loans, and when interest rates rise, those loans become more expensive. Typically, these are long term debts that are going to take years for you to pay them off. As such, increase in the interest rate will mean you’re going to carry the debt longer and pay more money.

In addition, higher interest rates mean it will be more difficult to take out new short term loans to help pay for unexpected expenses or to expand your business when necessary.

Bangladesh currently pays over USD 280.40 million approximately a year on its national debt. Higher interest rates increase the cost of government interest payments. This could lead to higher taxes in the future. Interest rates affect consumer and business confidence also. A rise in interest rates discourages investment; it makes firms and consumers less willing to take out risky investments and purchases.

In conclusion, if interest rates were to rise very quickly, it would yield dramatic, negative effects on bond prices, currencies, and effectively exploit growth in the real economy. Companies would suddenly and unexpectedly be hit with higher borrowing costs.

This would spoil earnings, increase in cost of capital, and dampen investment. Similarly, investors would see their net worth push if they invest in bonds. In theory, this situation would then begin to self adjust towards lower interest rates in order to ensure a good economy.

The writer is a certified finance specialist

 

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Published by the Editor on behalf of Independent Publications Limited at Media Printers, 446/H, Tejgaon I/A, Dhaka-1215.
Editorial, News & Commercial Offices : Beximco Media Complex, 149-150 Tejgaon I/A, Dhaka-1208, Bangladesh. GPO Box No. 934, Dhaka-1000.

Editor : M. Shamsur Rahman
Published by the Editor on behalf of Independent Publications Limited at Media Printers, 446/H, Tejgaon I/A, Dhaka-1215.
Editorial, News & Commercial Offices : Beximco Media Complex, 149-150 Tejgaon I/A, Dhaka-1208, Bangladesh. GPO Box No. 934, Dhaka-1000.

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