For a long time now central banks have been realizing a money policy as a result of which loan interest rates in many developed countries have been very high. Businesses and households benefit the most from such conditions, as their loans for investments and consumption have become cheaper. Governments of different countries benefit from it the most, as reported by economist of the Bank of Latvia Karlis Vilerts.
Decline of government bond value will be reflected in lower state consolidated budget interest costs – with 2016 as the lowest level since the economic crisis.
Lending costs in 2016 were one-third lower than the highest point (1.2% and 1.8% of GDP in 2011).
Vilerts explains: «The general interest cost reduction has been affected by the decline of government bonds’ interest rates. Although the government’s debt was one billion euros larger in 2016 than it was in 2015, interest rate payments have been 53 million euros lower. This means the debt has become cheaper, not smaller.»
The economist notes that the matter of how budget savings from lower interest costs were used has always been interesting.
«In Eurozone’s case, it is too soon to turn away from low interest rates. Especially considering that upcoming elections in multiple Eurozone member states could potentially increase political uncertainty and worsen the already fragile economic growth. The situation in the rest of the world, where talks about raising interest rates have been realized in practice (USA), makes us ask the question about the situation in Latvia. For example: what has been the effect of low interest rates on Latvia’s budget? Or is it possible that increased rates could result in excessive budget deficit?
Looking for an answer for the first question, the economist of the Bank of Latvia notes that 2016 seems notable. The state budget balance is predicted to have had been better than what is usual for post-crisis years, when budget deficit usually exceeded 1% of GDP. Although the end budget balance index is still being determined, such balance development under relatively low interest costs could mean that the government has used savings from low interest costs to reduce deficit and debt burden (smaller deficit – less money to borrow),» he explains.
«Nevertheless, looking at last year’s statistics, a different picture appears,» Vilerts says. Although interest rate costs have been declining for several years, there are no noticeable budget balance improvements. In addition, nominal budget balance outlook did not improve much in 2017 and 2018 in spite of interest rate cost reduction. The economist has concluded that 2016 may be one exception case, and savings from lower interest costs could be used to increase expenses other than debt burden reduction in a longer perspective.
«There is no single correct choice for use of savings. It largely depends on the economic situation in the country and the debt level. This is the factor that states if the focus of fiscal policy is put on stabilization of the economy or longevity of the state debt,» Vilerts says.
The economist of the Bank of Latvia notes that reduction of interest costs can be compared to winnings, which helps improve budget balance without raising other costs and thereby helps reduce the need for further growth of the debt.
«This is undoubtedly beneficial for all government, especially the ones with high debt levels. Nevertheless, the desire to spend immediately tends to be stronger. In addition, interest rate reduction is not always reflected in better budget balance. Often diverting savings to other expenses is explained with economic stimulation efforts aimed at restoring growth to a desired level,» as mentioned in the economist’s report.