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Studies: Global economy faces higher capital costs
December, 10th 2010

A new investment boom in emerging markets such as India and China coupled with a decline in saving rate in China is set to end the low interest rate environment in the coming years, McKinsey Global Institute has cautioned. In its latest report Farewell to cheap capital? The implications of long-term shifts in global investment and saving the global consulting firm has said that nominal and real interest rates that are currently at 30-year lows are likely to rise in coming years.

If real long-term interest rates were to return to their 40-year average, they would rise by about 150 basis points from the level seen in the fall of 2010. And they may start moving up within five years, the report said.

The rise in interest rates, translating into higher cost of capital for businesses, investors and governments, would however be slower if the saving rate were to keep pace with the rise in demand for capital. That seems unlikely even though households in the US and UK have started saving a lot more in the aftermath of the financial crisis.

However, the increase in global saving rate is unlikely to match the rise in demand for capital when the Chinese government is encouraging its citizens to increase their consumption. The country needs to bring down its saving rate from 53% of GDP (in 2008) to sustain its high growth rate. If the Chinese governments policies indeed succeed, global saving would decline by at least 1.8 percentage points of the global GDP by 2030.

Increased saving by households in the US and UK, if it continues to persist, can at best offset this decline in global saving rate by just one percentage point in 2030. The global saving rate would also be depressed by the increased age-related spending in many countries. Spending for the retired could increase by 3-3.5% of the global GDP by 2030, according to some estimates.

The McKinsey report noted that developing economies are embarking on one of the biggest building booms in history. The world is now at the start of another potentially enormous wave of capital investment, this time driven primarily by emerging markets. By 2020, global investment demand could reach levels not seen since the postwar rebuilding of Europe and Japan and the era of high growth in mature economies, it said.

The investment boom is already being experienced across Asia, Latin America and Africa, where the demand for new homes, transport systems, factories, offices, skyscrapers, hospitals and shopping centers has already caused a jump in investment. The global investment rate had increased from a low of 20.8% of the GDP in 2002 to 23.7% in 2008, and then dipped again during the global recession of 2009.

The authors of the report noted that given the emerging nations led by China and India have low levels of capital, high investment rates are likely to continue for decades, exceeding 25% of global GDP by 2030. If consensus forecasts of global growth are realised, global investment will amount to $24 trillion in 2030, compared with $11 trillion currently (in constant 2005 prices and exchange rates).

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