NEGATIV

E INTEREST
RATE POLICY
INTEREST

Presentation Outline
What is NIRP?
The Current Situation
Objectives
Implications for activity & financial stability
Negative Effects
Transmission to Money markets
Implications for sovereign bond yields
Effects in India
Conclusions

What is NIRP?
A negative interest rate policy (NIRP) is an
unconventional monetary policy tool whereby nominal
target interest rates are set with a negative value,
below the theoretical lower bound of zero percent.
People &
Businesses
hoard money

Collapse
inaggregate
demand &
slowdown or halt in
real production

Increase in
unemployment

What is NIRP?
A negative interest rate means thecentral bank and
perhaps private banks will charge negative interest i.e.
instead of receiving money on deposits, depositors must
pay regularly to keep their money with the bank.
In this upside-down world, borrowers get paid and
savers penalized

The Current Situation

Five central banks moved their policy rates below zero
1) Denmark's National bank (DN),
2) European Central Bank (ECB),
3) Swedish Riksbank,
4) Swiss National Bank (SNB) and
5) Bank of Japan (BoJ)

Objectives
In 2009, Swedens Riksbank was the first central bank to utilize
negative interest rates to bolster its economy
Eurozone, aim is to stimulate economic growth and to raise
inflation which is also below zero and even further to target of 2%.
Denmark and Switzerland immediate objective is to prevent
currency from rising too much. The idea of lower and negative
interest rates is to discourage investors from buying the local
currency, which tends to push its value up.
The Bank of Japanrattled global markets byadoptingnegative
rates in early 2016 to revive growth, raise price of import goods &
achieve inflation at 2 percent
Janet Yellen said in 2015 that a change in circumstances could put
negative rates on the table in the U.S.

Since central banks provide a benchmark for all borrowing costs, negative
rates spread to a range of fixed-income securities. By the end of April,
about $8 trillion of government bonds worldwide offered yields below zero.
Today, 30% of all bonds globally (over $7 trillion worth) yieldnegative
rates, up from <10% in 2015 and virtually 0% before 2014.Federal
Reserve Chairwoman Janet Yellen even indicated that the United Sates
could very well see negative interest rates, if warranted.

Interesting Facts

Implications for activity & financial

stability

1) Negative nominal rates help keep real interest rates below the
neutral level, they can boost consumption and investment
2) Increase in spending by liquidity-constrained firms and
households
3) Low or negative policy rates may help stimulate lending
4) Cantrigger a depreciation of currency which boosts exports
5) In countries concerned about capital flow-driven appreciation
pressures (e.g. Switzerland and Denmark), they discourage
capital inflows

Negative Effects
They can erode bank profitability by narrowing
interest-rate margins.
They can also encourage banks to take excessive
risks, leading to asset bubbles.
If more and more central banks use negative rates as a
stimulus tool, the policy might ultimatelylead to a
currency warof competitive devaluations.The BIS
warned in a March 2016report of great uncertainty if
rates stay negative for a prolonged period.

Negative Effects
Lower interest rates on deposits may cause large
sections of the economy to become cash-based
prompting investors to hoard their money under the
mattress. This may rob lenders of a crucial source of
funding and may even trigger a bank run.
Effect on money market funds While these funds
aim to avoid reduction in net asset values, their
objective would not be attainable if rates in the market
were negative for a sustainable period.

Negative Effects
Pension and insurance companies may struggle to
meet long-term liabilities.
Other case against negative interest rates is the folly of
relying on monetary policy alone to rescue economies
from depressed conditions. Keynes put it in a nutshell:
If we are tempted to assert that money is the drink
which stimulates the system into activity, we must
remind ourselves that there may be several slips
between the cup and the drink.

Deutsche Bank produced this graphic suggesting that lending

conditions might get tighter in a negative interest rate environment:

Transmission to Money markets

Introduction of negative policy rates does not appear to have affected the functioning of
money markets much. The pass-through to short-term money market rates has persisted, and
the impact on trading volumes appears in general to have been small.
In all jurisdictions, the overnight rate has followed the policy rate below zero. Moreover, the
negative policy rates have passed through to other money market rates.
In the euro area and Switzerland, money market rates track the central bank deposit rate.
In Sweden, money market rates closely follow the repo rate.
In Denmark, the relationship has been somewhat less tight. On some days the T/N rate is
close to the current account rate of zero, whereas on other days it is closer to (or even below)
the certificate of deposit rate. This volatility results from a thin market, where on some days
pricing can be driven by banks whose reserve holdings do not exceed their limit and earn a
higher current account rate.
In terms of money market volumes, experiences vary. In the euro area, money market
volumes were stable after the ECB's deposit rate went negative in mid-2014.. In Denmark, the
turnover in the (unsecured) money market has declined since the introduction of negative
interest rates. This decrease reflects, in part, the higher amounts that banks were allowed to
deposit "on demand" in their current accounts.

Implications for sovereign bond

yields

Policy rates provide the benchmark for short-term

borrowing costs throughout the economy. Thus,
negative rates in the Euro area, Denmark and
Switzerland has been accompanied by negative market
rates on government bonds, particularly the shorter end
of the yield curve.
Besides the role of negative policy rates, there are
several potential explanations for the emergence of
negative yields. These include
Very low inflation
The persistence of international savings glut
Flight to safety toward low-risk fixed income assets

Implications for sovereign bond

yields

The prospects of growing imbalances between the

limited supply of eligible bonds and rising demand under
the ECB quantitative easing program have pushed down
yields in core Euro Area countries, and, indirectly, in
other European counties.
Investors initially held on to these bonds on expectation
of further capital gains, which in itself helped push yields
to record low levels.
Speculative and arbitrage reasons
Institutional and regulatory requirements
Lack of alternative assets

NIRP Effects in India

Complicate the already complex task of currency
management for the RBI.
There will be extra currency volatility
But there is also an opportunity. Capital is cheap though
investors are showing risk aversion in the preference for hard
currency debt. Carry trades, borrowing in yen and euros to
buy rupee-denominated assets, would become very
attractive if that risk aversion could be conquered.
But the domestic policy environment must be improved for
that to happen.

Conclusions
The introduction of moderately negative policy rates by the four
central banks under review was by and large achieved within
their existing operational frameworks.
The experience so far suggests that modestly negative policy
rates are transmitted through to money market rates in much
the same way as positive rates are. It also appears that they are
transmitted to longer-maturity and higher-risk rates, although
this assessment is clouded by the impact of complementary
monetary policy measures. By contrast, so far retail deposit
rates have remained insulated, partly by design. And, at least in
Switzerland, negative rates have actually raised, rather than
lowered, mortgage rates.

Conclusions
Right now there are a whopping $10 trillion in total
negative-yielding sovereign bonds outstanding
worldwide, according to a report by Fitch Ratings. Just
as startling: 26% of the total value of J.P. Morgans
global government bond index has a below-zero interest
rate. The dynamic has even trickled into the corporate
sector, where there are more than $300 million worth of
negative-yielding bonds.
That has caused serious headaches for money
managers, especially pension fundsand insurance
companies in Europe, which must fightover the
increasingly scarce supply of relatively safe but

Conclusions
But theres not much evidence that its actually leading to more
lending or higher growth. Meanwhile, signs of distortions in the
system are growing, like data showing that sales of cash safes
are surging in Japan, as households lose confidence in the
banking system to protect their savings.
Torsten Slok of Deustche Bank Securities argues that better
results would come from targeted stimulus of governments.
Central banks have done what they can, he says, and now the
politicians need to do their job.
Events following the crash of 2008 clearly show that monetary
policy on its own cannot achieve a level of economic activity
close to its potential. The state must be involved.

In a negative interest rate

environment,