Impact of Interest Rates on Industry

For manufacturing investment, the real Interest Rate is important for determining the viability of investment. Generally, industry prefers real interest rates to be low, to encourage investment. High real interest rates discourage investment.

The Real Interest Rate is the Nominal Base rate – Inflation. If The Official Interest Rate is 7% and inflation is 5%. It means savings would increase in value by 2%. The real Interest rate is important for many reasons.

• Reflects the cost of borrowing. A higher real interest rate increases the cost of borrowing and makes investment less profitable. (This is not an issue if the finance is raised in UK) However, if it is necessary to borrow in the particular country the real interest rate is very important for determining the profitability of investment.
• Determines Economic activity. Interest rates influence the level of economic activity in the economy. Higher rates discourage borrowing and encourage saving. Therefore, in countries with high interest rates, consumption and investment tend to be lower. This could reduce domestic demand for your manufactured goods.
• Influences the exchange Rate. A high interest rate causes an appreciation in the exchange rate, making exports less competitive. If the manufactured goods are to be exported a high exchange rate can be quite a problem.
• (However, a strong exchange rate will make imports cheaper)

Negative Interest Rates. If a country has a negative real interest rate, I would see this as a warning signal. If inflation is higher than interest rates it will cause various problems.

1. Depreciating exchange rate.
2. Declining value of savings.
3. Capital Flight. People will seek to invest abroad where the real value of their money / savings can be maintained.
4. An economy with a negative real interest rate suggest that inflation is higher than the government can cope. Negative interest rates will only make inflation worse.

In the long term, negative interest rates will cause slower growth and therefore less demand for manufactured goods.