Correct Option
The correct option is 1 and 3 only.
Explanation
The cost of borrowing refers to the interest rate charged on loans. It represents the price paid for the use of capital. High borrowing costs directly influence the disposable income of households and the investment decisions of firms, serving as a critical channel for monetary policy transmission.
Statement-wise Analysis
- Statement 1 is Correct: When the cost of borrowing (interest rate) is high, the debt servicing obligation increases. Consequently, a larger proportion of the borrower's earnings must be allocated to repaying the interest and principal, leaving less disposable income for consumption or savings.
- Statement 2 is Incorrect: The repayment amount is not always less than the income of the borrower. In situations known as a debt trap, high interest rates or compounding debt can cause repayment obligations to exceed the borrower's current income. This forces the borrower to incur further debt to pay off existing loans, a common issue in informal credit markets or distressed agricultural sectors.
- Statement 3 is Correct: High interest rates increase the cost of capital for entrepreneurs. For a business to be viable, the return on investment must exceed the cost of borrowing. High costs reduce profit margins and increase financial risk, thereby discouraging individuals from starting new enterprises or expanding existing ones.
Key Takeaway
High borrowing costs reduce the disposable income of borrowers and disincentivize investment by increasing the cost of capital. If debt service obligations exceed income, it leads to a debt trap, negating the assumption that repayment is always less than earnings.