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Global Economy Faces Higher Capital Costs, McKinsey Study Says

The global economy faces an imminent end to three decades of low interest rates as emerging markets embark upon a building boom and aging populations drain savings, according to McKinsey & Co.

A shift toward investment and away from savings is set to drive up the cost of capital with long-term interest rates possibly starting to rise within the next five years, the research division of McKinsey, the international consulting firm, said in a study released today.

“Everyone who is in business has lived in a 30-year period when rates of interest have declined and that world is coming to an end,” said Richard Dobbs, a Seoul-based director of McKinsey Global Institute and co-author of the report.

While the researchers make no forecast for long-term interest rates, they estimated a return to their average since the 1970s would mean a 1.5 percentage-point increase. Costlier capital may mean that in the longer-run investors enjoy better returns from fixed-income investments and could reduce the value of equities, they said.

The McKinsey researchers estimated the investment rate of mature economies has declined since the 1970s, running $20 trillion less since the 1980s than if its rate had remained stable. They’re now betting the trend will reverse as worldwide investment increases from a recent low of 20.8 percent of gross domestic product in 2002 to more than 25 percent by 2030.

Boosting Investment

Driving the rebound in worldwide investment from $11 trillion today to $24 trillion in two decades is the likelihood that emerging markets including China and India will ramp up investment as their economies modernize, according to the report.

At the same time, savings will likely rise to around 23 percent of GDP by 2030, undershooting investment demand by about $2.4 trillion, as China’s economy becomes more consumer-driven and governments and companies elsewhere prepare for older populations by saving more.

“There’s going to be a squeeze on the availability of capital, which drives up interest rates,” Dobbs said.

The report concluded that the so-called savings glut of the last decade was the result of a falloff in demand for capital rather than an increase in the savings rate, which it calculates actually declined from 1970 through 2002 because of a drop in savings in rich nations.

In the new era, businesses will have to recognize that those achieving higher capital productivity, or output per dollar invested, will have a competitive advantage over their rivals as will those that can access direct financing, McKinsey said. Higher rates may also help commercial and retail banks, while in the longer-run investors may be able to record better returns from fixed-income investments than equities, it said.

Governments in advanced economies will need to find ways to promote savings and depend less on consumption, while those in emerging markets should develop financial markets to channel funds to the most productive investments, the report said.

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