Wielding the axe on interest rates

With the US Federal Reserve Bank poised to allow inflation moderately above 2%, interest rates in the US could remain low for as long as necessary to enable other economic areas in the US economy, such as the labour market, catch up. This decision will determine the price of borrowing and savings deposit rates, not just in the US, but across many EMs. In a recent turn of events, the Central Bank of Nigeria (CBN) lowered the floor on savings deposit rates from 3.75% p.a. to 1.25% p.a. This is an offshoot of the Oct’19 move by the apex bank to restrict local participation in the OMO market to only banks – a move that has driven risk-free flexion rates (such as the savings deposit rates and fixed deposit rates) down, even as inflation continues to tick higher.

At the previous floor of 3.75% p.a. on return on savings deposit, ₦100,000 kept in a savings account could attract ₦277.25 on a monthly basis after deductions for withholding tax (WHT) and transaction SMS notification have been made. Following the downward review of the rate, that return has been slashed to ₦89.75, down c.68%. However, in the spirit of competition, some banks could choose to pay deposit interest at a rate slightly above the regulatory floor, but this will be a not-so-good business idea in the ongoing unorthodox policy environment. While banks are compelled to lend to critical, but somewhat risky sectors of the economy (through the LDR policy) at a rate that is below the risk-adjusted rate, their ability to turn in a profit is also being crimped by the low-yields in the fixed income market.

Retirement/pension funds are not immune from the low-yields, as their return assumptions need to be reviewed. Safe assets will see a reduction in returns, as a result retirement plans need to be reviewed using lower return assumptions. This could be unpleasant for the many Nigerians whose retirement savings accounts (RSAs) do not have enough deposits. Many of them, upon retirement, rely on cash and cash-equivalents, like savings and fixed-deposit accounts, which suffer in low-interest rate environments. People living off their savings, which include many older people, suffer when interest rates are low. Anyone hoping to accumulate funds for a down payment, for child’s education, or retirement, is disincentivized from saving. You lose money saving in a low-interest, high-inflation environment.

Although there’s a crisis right now and lower interest rates is supposed to help stimulate the economy and prop up the stock market, for a country whose stock market has returned an annual average of -2.7% over the last five years, a return of 1.25% p.a. on a savings account that is incredibly liquid and virtually risk free seems like a pretty good offer. This could result in the pile up of money in people’s bank accounts. Our opinion is supported by the fact that broad money supply (M3) as at Jul’20 was 3.9% higher than Oct’19 levels – when the OMO market restrictions were introduced – and 8.4% higher than pre-COVID (Feb’20) levels. Also, investors in the Nigerian stock market still have a bearish bias towards equities as the return on the broad-market index, year-to-date, is still negative. All these negate the conclusions of the paradox of thrift that asserts that low-interest rates would discourage savings, and encourage spending and risk-taking and lends credence to our expectation of accumulated personal savings in the coming months, amid the odds.

The Federal Reserve’ Bank’s renewed commitment to lower interest rates for longer implies that both global and local interest rates may be low for a while. If you have money in a savings account and are reading this article, you’re probably disappointed in the 1% (or so) return you will be getting, going forward. You’re thinking that you can maximize the situation. Now that you know interest rates may be low for a while, we advise that you hold less cash – even though low interest rates set the scene for cheap credit. Your most suitable choice may be to simply pay off debts, if you have any. Other options that allow you to still be able to access your money could encounter other problems. If they’re stable investments, they’re usually pegged to reference interest rates, meaning you may not get a great return. If you opt for risky investments (like the stock market), you’re taking on a risk where you could lose some of your balance.

Amid dampened economic activity and its adverse impact on people’s income and savings, personal loans have become an easy way to meet credit requirements. Existing debts are likely to have interest rates greater than 1%. Servicing debt obligations ties up funds and debtors are not able to fully take advantage of investment opportunities, when they present themselves. Early payment of debt frees up funds for future opportunities. As such, paying off debt is the best choice as long as you keep a healthy emergency fund in a stable, easy-to-access savings account. For new borrowers, this is a good time to take a loan, especially on mortgage. Existing debtors can refinance existing debts, at a cheaper rate, to save some money. If you don’t have any debt or do not have need for debt, you could explore other investment options at your own discretion, but still keep an emergency fund.

Accumulation of emergency funds will certainly contribute to the existing war chest of liquidity, that is currently worth about 26% of GDP. In our opinion, these savings are a private vice, but a public virtue. This is because we believe the monies in the financial sector will flow back to the economy over time. These savings can support spending in the economy, when fiscal stimulus is tapered. All those savings in people’s bank accounts may not be good news for the individuals at this time, but when the economy is set to recover, the liquidity could encourage higher consumption and investment spending that will bring about more jobs and possibly higher incomes. Another important perspective to wielding the axe on interest rates – which only time can provide clarity on – is the impact it will have on the banks’ cost of funds. Already, most people are usually ineligible for interest on savings because banks usually have a ceiling on the number of withdrawals permissible on a savings account to qualify for interest within a given period. Therefore, since people are not earning it – based on the rules -, the banks are not paying it either. So, the impact on the banks – in terms of reducing their cost of funds – may be overrated.

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