What exactly happens step-by-step when Developed governments tapper their bond intrest rates , what is the relation between fast economic growth and high bond intrest rates , and how does it affects a developing country like India?
Share
Please briefly explain why you feel this question should be reported.
Please briefly explain why you feel this answer should be reported.
Please briefly explain why you feel this user should be reported.
A transparent and exhaustive explanation of the effect of interest rate tapering is so daunting that even the very policy makers struggle with the same. The explanation provided below will at most give you a framework/perspective of what ought to happen based on my view, however, you need to research more.
Interest rates are both a barometer as well as a tool to control the economy. Tapering the same is essentially something that Policy Makers do in order to pump prime the economy from a recession. (Essentially pulling the economy out from a situation when the Actual GDP of the country is lower than the Potential GDP of the country, i.e. the economy is operating below it’s potential). Tapering the interest rates ultimately effect the consumption and investment decision, since lower interest rate is transmitted to even the local and regional banks. A lower interest rate discourages savings and encourages consumption, at the same time, makes the cost of borrowing for the business sector amiable, provides ample investment opportunities for companies, effectively increasing the C and I component of the GDP equation ( C+I+G+X-M), thereby, boosting the GDP as well as the growth rate in GDP of the nation.
The relation between fast economic growth and high bond interest rates is inverse, as stated in the previous paragraph. Moreover, a lower bond interest rate discourages people to invest in bonds ( since interest rate is low, therefore bond prices are high) and encourages people to move towards riskier asset classes like Stocks and Real Estate in search of returns. Thereby, money is squeezed out from the bond market to the stock markets or Real Estate markets, fostering faster economic growth.
The cult of Globalization has linked every single economy with one another. Anything that happens outside especially in developed nations, will have rippling effects throughout nations. Essentially FIIs in search of higher returns would prefer borrowing at a lower interest rate ( say borrowing from US as a result of tapering or borrowing from Japan) and investing in countries like India which maintains a higher interest rate. So in a way money is flowing out from US and finding it’s way to emerging nations like India and Brazil, in a way resulting in INR or BRL appreciation. This is known as carry trade. Of course, once reversal of tapering happens, momentarily there will be a shock in the developing economies like India the Carry Trade will reverse and there will be an outflow of funds.