What is Negative Interest Rate?

Full Question: What is negative interest rate? Is it Helping Japan?

Interest rate is a very important economic tool in the hands of central banks. A high interest rate discourages business from borrowing and thus adds as brakes on the economy. Conversely low interest rates are supposed to spur borrowing (presumed for fresh investment) and consequently boost the economy and growth.

Interest rate is not a tool in isolation. The governments have other tools. Creating more liquidity in the system to encourage businesses to borrow and invest. Printing money, given very technical sounding name to camouflage the dirty act, ‘Quantitative Easing’ has been used for a few years in a row by the US and now being repeated by Europe and Japan, is an extreme measure of the liquidity tool.

Cutting down tax rates is a fiscal measure to promote growth.

All these and other techniques have been used governments to spur growth some times very effectively and some times with poor results. Tools have limitations. They are not panacea.

Coming back to your question “Is it helping Japan?”, it seems it is not helping much. Japan and many mature economies have been languishing for the last few years. In fact, in my opinion, the global economy has actually not recovered properly since the global economic collapse post Lehman Brothers incident in 2008. All the stimulus packages have just managed to prop up otherwise slump economies.

We must appreciate that various monetary and fiscal tools are temporary jigs that can address a sudden temporary glitch in an otherwise sound economy; they can not address deep fundamental issues like saturated economies.

US, Europe, Japan and China have reached saturation after rapid economic progress. These countries can no more grow at a rapid pace internally. For a few more decades they managed to grow by helping other developing and under developed countries. While there is tremendous potential to grow on the back of developing and underdeveloped countries there are severe limitations too! Many of these countries do not have the wherewithal to pay for the development. Many other do not have required political stability. All these factors limit the possibility of internal growth based on external activity.

In conclusion, in my opinion, in the face of many complex global challenges, low interest rates have not been helping Japan. I doubt wether rates helped other countries either. The US is showing signs of growth but we cannot attribute this to low interest rates or other measures alone. Perhaps after a prolonged recession she has returned to natural growth?

Please Note: This is almost a reproduction of the question I had answered on the website ‘Quora’, which I thought could be useful to the visitors to this blog site also.

What is an Exchange Traded Fund?

An 'Exchange Traded Fund (ETF)' is special type of mutual fund. It closely mirrors popular stock indices like the 'BSE S&P Sensex' or 'NIFTY' or 'NIFTY Junior' and so on.

Every stock index comprises of select company shares in certain proportion or weigh  which is determined and disclosed by the index. The popular Sensex comprises of the top 30 companies by 'Market Capitalisation'. Once in a while the index is recast. A new company may replace an existing one.

Through an ETF instead of buying individual shares of a company you can buy the specific index itself. For example suppose you are interested in capturing the growth of the NIFTY, which constitutes the top 50 companies by market capitalisation of all the companies listed on the NSE, you have two options, as follows:

1. You can keep track of the index yourself, buy the individual shares in the same quantity as the index and making necessary adjustments as and needed, based on the actual changes in the composition of the index, which is a tedious and time consuming process.
2. Alternatively you can buy the ETF of the index you want to track. The drudgery is taken care of by the fund which created the ETF.

Here I present the various types of ETFs offered by Golaman Sachs in India:

Let us examine the composition of GS Nifty BeES.

The above picture depicts the composition of the GS Nifty BeES as on 1st August 2016.

 For the efforts taken to create and maintain the ETF, the sponsoring mutual fund charges a small annual maintenance fee, besides again reasonable purchase and redemption charges. The greatest advantage of an ETF is the low maintenance fees, usually less than 0.50% per annum. In contrast, mutual funds charge higher fees in the range of 1 to 2.25% per annum, besides the entry and exit loads.

The ETFs can be purchased just as you would purchase shares on the stock market. They are listed along side and among equity shares. This means it saves you the trouble of making an application form with the mutual fund for purchasing and redemption of units.

In conclusion, in my opinion ETFs are much better than mutual funds on account of ease of transaction, low charges as well as efficiency of long term wealth creation.