* * *
IMF Introduces Floor on Interest Rates
By Robin Harding
Financial Times, London
Friday, October 24, 2014
http://www.ft.com/intl/cms/s/0/9b3ea266-5bcc-...144feab7de.html
WASHINGTON -- The International Monetary Fund has been forced to change the calculation of its most important interest rate after aggressive monetary easing around the world threatened to turn it negative.
Late on Friday the IMF said it was introducing a floor of 0.05 per cent for the interest rate on Special Drawing Rights, its own form of international currency.
The IMF's move shows how global financial conditions are now easier than they have ever been, more than five years after the end of the Great Recession, leading to the lowest interest rates in its 68-year history.
Rate cuts, asset purchases, and forward guidance by central banks around the world continue to disrupt financial markets, forcing participants to adapt in new ways.
"In view of the prevailing interest rates today, the SDR interest rate for the next weekly period starting Monday October 27, will be established at the floor of 0.05 per cent," the IMF executive board said.
The SDR rate is what the IMF pays to its lending nations for the use of their funds. It then adds a margin to calculate the rate on its loans to Greece and other countries. The change will ensure lenders get a small positive return and fractionally raise costs to borrowers. The rate is calculated as a weighted average of the three-month risk-free rates in euros, yen, dollars, and sterling.
After staying positive throughout the financial crisis, that basket has threatened to turn negative in recent weeks, as both the euro and yen rates have fallen below zero. They were affected by the European Central Bank's move towards negative rates and continued easing by the Bank of Japan.
The most recent weekly calculation came in at 0.03 per cent. That reflected a euro rate of minus 0.02 per cent, a yen rate of minus 0.01 per cent, a dollar rate of plus 0.01 per cent and a sterling rate of 0.05 per cent. That rate will now be replaced by a 0.05 per cent floor from next week.
The possibility of negative rates caused several problems, according to a senior IMF official. There is no legal basis in its articles of association for paying a negative rate; it would have created a perverse situation where creditors were paying to lend money to the fund; and it would have frozen the SDR market as no country would have any reason to participate.
It would also have caused a breakdown in the IMF's "burden sharing" mechanism. Under that system, credit losses from countries that do not pay their IMF loans are shared between members, via a small deduction in the interest they receive.
* * *
