Economy, Business And Markets

Interest Rate; Double-Edged Sword

Interest Rate; Double-Edged SwordInterest Rate; Double-Edged Sword

Interest rates of investment accounts in commercial banks fell slightly at the beginning of the Iranian month of Dey (starting on December 22), in line with the new instructions issued by Central Bank of Iran (CBI).

The lower interest rate offered by the commercial banks is considered to act as a double-edged sword by economists. The immediate outcome of such policy is that it will encourage investors to turn to alternative markets in search of more profit.

Studying the trends and experiences from previous years, two different groups of investors are identified in this market:

The first group of investors generally intended to invest their cash in markets with medium risk, such as the stock exchange or mutual funds. With lower interest rates they tend to pull out their money that may, in turn, stimulate the capital market. On the other hand, the cost of borrowing money for industries would fall in the short to medium term. What may happen, over the course of the short term is a slight increase in production and growth within the capital markets.    

The second group of investors tend to use money in the short run, but due to high inflation rates, they are always looking for investment opportunities that could protect the value of their cash against inflation and at the same time have high liquidity. These investors are more interested in foreign exchange market or capital assets such as automotives that are considered to be highly liquid assets.

The cash injected by this group of investors to the foreign exchange market may increase the liquidity, creating an increase in the dollar exchange rate versus rial. In addition, the cash provided by floating investors is dangerous for any market they would approach. This scenario has happened several times in several markets over the past 3 years and is known as a major reason for increasing prices within different markets.  

Both these groups generally prefer to invest in high interest rate investment accounts where they can both get certain levels of interest and benefit from high liquidity. When the CBI announces a reduction in interest rates these two groups are first to become shaky about the future losses.

As it is necessary to create an interconnection between the interest rate and inflation rate in every economic system (as long as inflation rate is falling then the commercial banks have to lessen their offered interest rates), the CBI needs to be cautious about the effects of low interest rate on foreign exchange market and money-supply.