Will interest rates keep rising?

For a long time, interest rates have been going down, globally. So, the rapid rise in interest rates through 2022 and early 2023 has left many wondering if this trend will continue. Well, in India the RBI has paused interest rate hikes but has not ruled them out completely, considering that inflation has been a concern (though currently it seems to be on the decline).?But then there is the growing threat of El Nino, the weather phenomena that may affect the annual rainfall, which could in turn affect crop output, which may in turn result in food shortage, raise prices and therefore raise inflation. Rising inflation may compel the RBI to raise interest rates again.

But in the long term, interest rates are likely to continue to decline not only in India, but globally too.?

To understand why interest rates, show a declining trend in the long term, consider both local and global factors. The global economy does have some impact, but it's not the main driver. Growing economies like India attract investments from advanced economies like the US and European countries, which raise interest rates. But because growing countries like India have a lack of sufficient safe places to invest, a lot of the money ends up back in advanced economies, lowering interest rates. For example, the Indian government has over $220 billion invested in US government securities and is the 11th largest holder of US government securities in the world.

Over the past few decades, India has generally experienced a downward trend in interest rates. Here are four indicators that point to this trend:

1. Repo Rate: The repo rate, which is the key policy rate set by the RBI, has shown a downward trend over the years. For instance, between 2000 and 2023, the repo rate decreased from around 9.05% to 6.5%. This reduction in the repo rate indicates a general decline in interest rates. For the uninitiated the repo rate is the rate at which RBI lends money to commercial banks and financial institutions to meet their short term requirements.
2. Inflation: One of the primary factors influencing interest rates is inflation. India has witnessed a declining inflation trend over the past few decades. Inflation erodes the purchasing power of money, and when inflation is high, central banks tend to raise interest rates to curb it. As inflation comes down, the RBI will have more room to lower interest rates. If you compare, average inflation increased from 2000 (4.02%) to 2022 (5.90%), but during this period it touched a high of 12.11% in 2010 following which it has generally been in decline.
3. Economic Reforms: Various economic reforms, such as financial liberalization and improved monetary policy frameworks, have played a role in reducing interest rates in India. These reforms aimed to enhance the efficiency and competitiveness of the financial sector, leading to lower borrowing costs.
4. Global Factors: International trends and global interest rate movements can also impact interest rates in India. Over the past few decades, there has been a general decline in interest rates globally. Factors such as accommodative monetary policies in major economies and global economic conditions have influenced interest rates in India as well.

However, the factors that affected interest rates in the past will likely continue to do so. In advanced economies like the US, interest rates will probably stay low. As emerging market economies like India catch up with advanced technology and begin seeing aging populations, their interest rates will gradually decrease and become similar to those in advanced economies.

But keep in mind that we live in a rapidly changing world, so things can change. For example, if governments continue to support their economies after the pandemic, it could increase their debts and raise interest rates. On the other hand, if countries invest in clean energy and receive subsidies, it could lower interest rates. Also, if countries become more separated in trade and finance, it could raise interest rates in advanced economies and lower them in emerging markets.

Overall, the recent increase in interest rates may be temporary. Once inflation is back under control, central banks in advanced economies will likely reduce interest rates to where they were before the pandemic. How close they will get to those levels depends on other factors like government debt and financial changes. In large emerging markets like India, interest rates are expected to slowly become similar to those in advanced economies.

In conclusion, consider elevated interest rates that are being seen in India currently as an opportunity to invest, they may not last for long.

Source: world bank

Author: Ashish Joseph George, MMS, CFP and some AI too. The views shared in this article are my personal views and don’t reflect the views of any organization. This is not an investment advice