The current situation of negative interest rates is definitely the talk of the fall. Dr. Mohsen Adel’s paper interestingly draws practical conclusions on the possible positive impact of negative rates on global growth. Dr. Adel has also rightly suggested that Egypt could take advantage of this unusual situation to rebalance public debt.

Although it may be hazardous to predict when (and if) interest rates will go up again, we can still confirm that the current policy has had very little impact on growth, and more recently, even a lesser impact on stock prices.

Dr. Adel stressed the fact that the Euro-zone suffers from slow growth, while inflation & interest rates are close to zero or negative with damaging impacts on the real economy and financial markets. Some recent research avenues may help us understand this paradox and the puzzling facts Dr. Adel mentions:

The risk premium may me growing. And a higher risk premium hurts both the real economy, and (lately), the stock exchange.

According to a research published this summer by economists from the BIS (https://www.bis.org/publ/work794.htm), return on average capital employed or ROACE has been rather stable over the last decade (4.9% pre-2008, 5.3% today), while 10y-interest rates have dropped dramatically (4% then .8% now)! i.e. investors are still requiring the same ROACE even though the risk free rate has fallen. The market is definitely more cautious about corporate investments and screams by requiring much higher risk premiums.

This trend is even more obvious in the global stock market: Corporate discount rates have been barely steady, at 6%, which comes as a surprise because of falling interest rates: pre-2008, the risk free rate was approx.4% which puts the risk premium at 2%. Today, the risk free rate is less than 1% while the corporate discount rate still sits at 6%. i.e. the market is requiring a 5% risk premium on corporate stocks, more that 2 times what they asked 10 years ago.

Why happens to risk premiums? We don’t’ know for sure, but public wisdom is cautioning us about increasing risks in the global markets, (trade wars, Brexit uncertainty…) reducing corporate investments and slowing global growth.

How does this situation impact Banks? Dr. Adel mentioned the eviction effect (Banks lend to government instead of lending to corporations or individuals). This is absolutely true, for the very reason that falling bank margins hurt significantly earnings and ultimately, return on equity. Average ROE for Eurozone banks are down 10% (pre-2008: 15%, today: 5 to 6%), preventing banks from accessing new equity (which explains why their size is shrinking!) and pushing them out of the lending market. Instead, Banks do prefer to lend to governments, a sort of “Japanese Syndrome” that seems to affect Euro-zone nations and beyond. It is also affecting the U.S market, at a lesser extent though, since more diverse & efficient financial markets there do offer better credit access to corporations.

Dr. Adel has shown that we may take advantage of the current status. We must indeed.

Dr. Sami B. Chaouch