The US Federal Reserve has repeatedly lowered interest rates this year. Taiwan's central bank has followed suit, lowering rates by a total of 0.75 percentage points, a relatively conservative margin compared to the 2 percentage point cut in the US. But an era of low interest rates has undoubtedly arrived.
The central bank has lowered rates in order to stimulate the economy. In the US, the stock market rebounds every time rates are lowered. The lower long-term cost of capital also helps raise private-sector investment. But undeniably, lower interest rates also bring higher risks, as exemplified by Japan's experience.
In the 1980s, a continuous increase in Japan's trade surplus put pressure on the yen to appreciate. The Bank of Japan continuously lowered rates to ease the pressure. Japan's so-called zero-interest environment took shape under these circumstances.
Life insurance companies suffered the most in this low-interest financial market. The majority of policies are fixed-interest rate contracts. When the market interest rate goes lower than the rates of insurance policies, revenues generated through the use of capital become insufficient to pay for the insurance policy interest rates. If this continues over a long period, insurance companies that can't hold on any longer will go bankrupt.
Since 1998, 18 Japanese insurance companies have faced crises. Similar situations have also occurred in the US and UK, but on a less serious scale.
What's even worse, the Japanese government has continuously issued debt to stimulate the economy. The government debt has totaled more than twice the country's GNP. At the same time, most of the government bonds issued under the zero-interest environment are in the hands of banks and insurance companies. Therefore, once rates rise, the value of the bonds inevitably falls to reflect the change. This has a tremendous impact on the revenues of financial institutions.
Due to this kind of zero-interest effect, Japan does not dare readjust rates against a backdrop fraught with financial crisis. For this reason, the interest rate issue has complicated Japan's financial crisis and made it harder to resolve.
Taiwan is also gradually entering an era of low interest rates. Most of the policies held by Taiwan's life insurance companies are fixed at interest rates of around 7 percent, while the market rate has already fallen to between 4 and 5 percent. Some insurance companies have lowered the rates of their new policies and some have even adopted floating interest rates. However, the older companies have larger numbers of high-interest rate policies and are therefore under greater pressure. This kind of imbalance in the interest period structure is expanding by the day, due to the central bank's lowering of rates.
It is still hard to predict whether we will see a Japanese-style life insurance crisis, but the seriousness of the problem cannot be overlooked. Similarly, depending on the seriousness of the economic decline and the scale of government policies aimed at expanding domestic demand, the government will float more and more public debt. Under such unfavorable circumstances, it appears interest rates can only be lowered but not raised. If things go on like this, Taiwan may follow in Japan's footsteps.
Seen from this viewpoint, interest rate policies do have their limits. Taiwan's central bank cannot ignore the after-effects such policies will have on the financial industry. Moreover, how to defuse the lurking crisis in the life insurance industry is another problem that the Ministry of Finance will have to face.
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