High Interest Rates

By: EconomyWatch Content   Date: 2 November 2009

About The Author

EconomyWatch Content

Follow The Money

EconomyWatch, Content Team

 

  • Dot Div
  •      

High interest rates are indicative of the growing demand for credit in a financially sound economy and are driven by several factors.Besides various domestic factors, several international factors also play a key role in driving interest rates.

Factors Driving High Interest Rates

Several factors drive high interest rates. Generally, a country’s central bank decides the level of the base rate or the prime lending rate which sets the precedent for other types of interest rates. The following are set on the basis of the base rate:

  • the interest rates paid by banks on deposits and other investment options

  • the interest rates charged on various types of loans and other products 

The central bank of a country decides the level of interest rates by considering:

  • the overall economic scenario

  • the inflationary concerns

  • the credit demand-supply gap

High interest rates are prevalent when the economy is growing, consumers have jobs and they are able to save significant amounts while borrowing to purchase high end durables such as cars and houses. This increased demand for credit results in high interest rate which leads to the rationing of the funds available in the system.

It is important to know that inflationary pressures also result in high interest rates. Lenders demand a higher interest rate so as to compensate for the decline in the purchasing power of the funds due to the inflationary pressures.

The actions taken by a government and the level of its budgetary deficits play a key role in deciding the level of interest rates. Similarly, the level of foreign investments reduces the demand for domestic credit and drives the interest rates down.

Other factors resulting in high interest rates include:

  • a country’s political and financial stability

  • movements in the foreign exchange market

High Interest Rates Reflect Higher Risk

High interest rates are usually a reflection of the risk level associated with an investment. Investments of longer duration generally carry a higher interest rate than short term investments. Similarly, the interest rates on riskier investments such as sub prime loans or investments in relatively new projects or companies are higher than the rates of prime loans and well established companies.


  • Dot Div
  •      

Most Popular in Interest Rates

Related Links
blog comments powered by Disqus