Rates to remain relatively low as global economy strengthens: IMF

The cost of borrowing in global economy is likely to rise only modestly with the normalization of global economic conditions, as factors pushing down the rates in the past are unlikely to substantially reverse soon, the International Monetary Fund (IMF) said on Thursday.

In an analytical chapter of its latest World Economic Outlook report, the IMF argued that the real interest rates worldwide are expected to increase in the medium term as global economic conditions improve, but "there are no compelling reasons to expect that long-term real interest rates will quickly return to the average level of 2 percent observed during the mid-2000s."

The main reason, the Fund said, is that the factors that have mostly contributed to the decline in real rates in recent years are unlikely to reverse substantially over the medium term.

The large increase in emerging market economy saving rate between 2000 and 2007 is expected to be only partly reversed, implying only a modest increase in real rates, said the IMF.

It also noted the trend of higher demand for safe assets since the onset of the financial crisis will persist.

Furthermore, scars from the global financial crisis have resulted in a sharp and persistent decline in investment in the advanced economies. The investment-to-GDP ratios in many advanced economies are unlikely to shift back to pre-crisis levels during the next five years.

The prospects of continued low borrowing costs will benefit borrowers and debt-laden countries which have been struggling to achieve fiscal sustainability. But it also weighs down returns of pension funds and other financial products with defined benefits.

Savers in general may suffer and financial institutions may be induced to search for higher yields by taking on more risks, according to the report.

"It could also increase the probability that the nominal interest rate will hit the zero lower bound in the event of adverse shocks to demand with inflation targets of around 2 percent," the report cautioned, referring to policy limitation the central banks in the advanced economies may encounter if risk of sharp economic slowdown materializes.

The Fund's view echoed the U.S. Federal Reserve's judgement to some extent. The U.S. Central Bank said after its March policy meeting that even after employment and inflation are near reasonable levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Fed views as normal in the longer run.