Low interest rates have little merit: Rajan

The new head of India's central bank is questioning whether current ultra-low interest rates are the right way to return to growth after the financial crisis.

Raghuram Rajan, the head of the Reserve Bank of India (RBI), says central banks warded off a collapse of the global financial system through bank bailouts and rate cuts. Central bankers, he said, were "heroes" for halting the collapse.

But global growth since then has been disappointing and Rajan said it was time to ask if there were better tools than the rock bottom rates used by major central banks in the rich world, including the US Federal Reserve, Bank of England, Bank of Japan, and European Central Bank. Rajan said low rates could have unintended consequences. He says, for instance, that they could encourage people in their 60s to save instead of spend, because low returns mean they are unable to reach their retirement savings goal.

At a speech in Frankfurt, Rajan said he didn't have the answers but said it was time to ask, "Are ultra low rates the solution or part of the problem?"

Low rates can encourage banks and financial institutions to invest, but Rajan questioned whether that was leading to an increase in new businesses. "There may be no connection or only a limited one, if uncertainty holds back investment," he said. He underlined that low rates "do create financial system stresses which could set the stage for another crisis".

Appearing at Frankfurt's Goethe University to accept the Deutsche Bank prize in financial economics, Rajan said he was making a last speech as an academic economist instead of as a central banker. Rajan, the former chief economist at the International Monetary Fund, won plaudits for predicting the possibility of a global financial crisis before the turmoil began. He is on leave from his post as finance professor at the University of Chicago.

Analysts believe, as banks tighten their purses in a slowing economy, corporates are borrowing through NCDs and it becomes a good investment opportunity for debt investors because of the high interest rates offered, which is anywhere between 10 per cent and 14 per cent. Recently, NBFCs and gold loan firms like Muthoot and Mannapuram Finance had issued NCDs bearing a coupon of 12-14 per cent per annum.

Asked about RBI's policy stance, Rajan said, "At this point we are neutral, we will see how things develop."

"Unfortunately there is still some inflation when you strip out the effects of food and energy. Therefore, it is not just food, it's other factors also which are driving inflation," the RBI Governor said.

While presenting the prize to Rajan, Deutsche Bank co-chairman Juergen Fitschen on Thursday had said that it would have been hard to find a more deserving winner for this year's award.

The academic prize is sponsored by the Deutsche Bank Donation Fund and carries an endowment of euro 50,000. The Centre for Financial Studies (CFS) awards the prize biannually in partnership with Goethe University Frankfurt.