Negative real rate of interest is encouraging credit growth

I was reading about the real interest rate in the Economist and it struck a chord on the problems of the current global economy. In case you're not sure what's the real interest rate, it's the interest rate adjusted for the expected erosion of the purchasing power due to inflation. Like Singapore, many countries around the world have negative real interest rates since the global recession in 2008.

Negative interest rates have been associated with fueling faster credit growth and inflation, and judging from Singapore's blistering growth of 14.5% last year, Singapore has all the signs of an overhearing economy. I estimate for the year of 2011, the inflation rate may hit at around 4.5% to 4.6%, an increase of almost 2% from the year 2010. Not only that, our credit growth rate has been making headlines if you have read the news on our property prices.

If this continues, the outcome that I can see is a vicious cycle. Credit growth will grow by double digits fueled by the super low interest rates, driving up inflation. This does not translate into wage growth due to the "productivity drive" that is being encouraged here, and the profits are fueled more by credit than innovation. Pricing of common necessities will start to rise to uncomfortable levels.

Growing at such a breakneck speed will result in growing pains. The only solution that I can see is for the interest rates to increase to reduce the negative real rate of interest. This will restrict credit growth and inflation, giving the economy a breather to take stock on what has happened for the past year.

Will this happen? Not that I can see as long as increasing the GDP is the KPI for the government. High inflation for this year? Most probably, and the increase of electricity bills is just a start.