Prolonged ultra-low interest rate environment may hurt growth: Tharman

International cooperation needed to enable future growth even as governments tackle pandemic, say speakers at DBS Asian Insights Conference 2020

Fri, Jul 24, 2020

Janice Heng


WHILE aggressive action by central banks is the right move in this economic crisis, a prolonged ultra-low interest rate environment might hurt growth, said Monetary Authority of Singapore chairman and Senior Minister Tharman Shanmugaratnam on Thursday.

More international cooperation will be needed on this front and others, such as preventing the emerging world from "submerging". And as governments tackle the Covid-19 crisis, they must move from preventing collapse to enabling future growth.

Mr Tharman, who is also Coordinating Minister for Social Policies, was speaking with University of Chicago professor Raghuram Rajan in the keynote conversation of the DBS Asian Insights Conference 2020: Navigating A Post-Pandemic World.

Both speakers warned of the problems of an ultra-low-rate world. Even before Covid-19, there was an extended period of low interest rates and substantial liquidity, said Mr Tharman. "We entered this crisis with a lot of risk in the system already." Yet this may not have had a significant payoff in terms of corporate investment.

A very long period of low or negative interest rates will hurt long-term money management, including pension funds. With people less prepared for retirement, they may save more and consume less.

"So we need to be a little sceptical about this strategy as a means of promoting growth," he said.

Prof Rajan, former International Monetary Fund chief economist and former governor of the Reserve Bank of India, flagged the risk that below a certain level of interest rates, there may be a reverse effect as banks themselves find it harder to lend.

While so-called modern monetary theory posits that a low-rate environment without inflation would allow the public sector to run larger deficits, there is no free lunch, he added.

If governments must spend more on servicing debts, this means less money for the "fundamental purposes" of fiscal spending, such as education and health, said Mr Tharman.

Modern monetary theory may be tested in a "natural experiment", as central banks in emerging markets expand their balance sheets. But the consequences of failure will be global.

Most of global growth comes from the emerging world, and much depends on whether it will "continue to emerge", noted Mr Tharman. Yet, there is a very real risk of a "submerging world" instead, if low growth and rising unemployment erase the gains made in the last two to three decades.

There needs to be a strong multilateral response, he added. In the global financial crisis, the world agreed on an issuing of special drawing rights to provide liquidity; this time around, such a proposal has not been fully supported. Governments must realise that their interests are tied to those of the rest of the world, he said.

This extends to trade and investment. While the world retracts somewhat from the hyper-specialised global supply chains of pre-Covid-19 days, it would be a grave error to retract altogether, said Mr Tharman. Diversification of supply chains is the answer, rather than trying to bring everything onshore.

As economies tackle the Covid-19 pandemic, the objective shifts from preventing an absolute economic collapse to also preserving capabilities and allowing for growth.

Preserving capabilities includes helping people stay in jobs or get back into work quickly, said Mr Tharman, who chairs the new National Jobs Council. Governments should help firms bring forward hiring rather than waiting, to reduce the time that people spend out of work, he added. This requires trust in the system, "where everyone knows that it pays for us all to do our part".

Enabling growth is harder than it sounds, given the profound uncertainty around the pandemic, he said. Governments will find it hard to tell which firms or sectors may remain viable in the future, but should still try to "sense the next wave" in the market and spread that through the industry.

Transitioning out of the first phase of massive government support will come with its own problems, said Prof Rajan, who noted that the second or third quarter of 2021 will probably be the earliest that economies may return to full operation.

"When the economy opens up more fully, there will be more damage that will be uncovered," said Prof Rajan. Many firms will simply not reopen, contracts may fall through, and debts will have to be reckoned with.

As the corporate impact unwinds, the "last shoe, which hopefully will not drop", is the effect on the financial sector.

Governments must keep in mind the burden that financial companies will bear, and work to avert a financial sector crisis as well, he said.