Higher interest rates are coming … a look at the winners and losers
Many Namibians don’t pay much attention to what Bank of Namibia Governor Ipumbu Shiimi and his Monetary Policy Committee (MPC) does, but that could change very soon. An interest rate hike of 25 basis points (bps) expected to be announced on February 17, 2016 will impact everyone who has a home mortgage, car loan, savings account or money in the stock market. In short, life is about to get better for savers and a little harder for borrowers. Investors won’t escape the wrath either as they could also face tougher times. In this article, I will help my fellow countrymen make sense of this announcement by way of summarising who amongst them will win and who will lose following the Bank of Namibia’s decision to make borrowing more expensive. Winners: Savers For a long time in Namibia, savings and money market accounts had offered very low interest on average ranging between 4.5 percent and 4.9 percent, thus the announcement because yield across the board will now become favourable. Following a period of low interest rate that came as a result of the financial crisis, people who put their money in the bank endured a period of disappointment and anguish as they have gained next to nothing from their savings. With interest rates so low, people who played it safe have been getting the short end of the stick. Following the governor’s announcement, things will change for the better for people with savings accounts as savers will now gain more interest on the money they deposit at their banks. Of course this benefit is predicted on the assumption that an increase in interest rates won’t be accompanied by an increase in the inflation rate, which can erode the purchasing power of cash savings. But given the lower inflation rate, 3.7 percent (December 2016), surely savers can realize some reasonable returns from their savings. This is definitely the right time to place excess money in the savings and money market accounts and stand a chance to realise reasonable returns. Winners: Banks Commercial banks are perhaps the biggest winners in this game. As you know, banks make money by borrowing at low short-term interest rates (imagine checking and savings deposits) and lending it out at higher, longer-term rates. So a rate hike will give banks a window of opportunity to earn more attractive “spreads” once the Bank of Namibia moves. How does this work? Well, picture this: The banking sector’s profitability increases with interest rate hikes. Institutions in the banking sector such as retail banks, commercial banks, investment banks, insurance companies and brokerages have massive cash holdings due to customer balances and business activities. Increases in the Repo rate directly increase the yield on this cash, and the proceeds go directly to earnings. Still can’t get it, okay, imagine a similar scenario, what will happen to the profitability of oil drillers when the price of oil rises! These companies hold their customers’ cash in accounts that pay out set interest rates below short-term rates. They profit from the marginal difference between the yield they generate with this cash invested in short-term notes and the interest they pay out to customers. However, when rates rise, this spread increases with extra income going straight to earnings. For example, a brokerage has N$1 billion in customer accounts. This money earns 1 percent interest for customers, but the bank earns 2 percent on this money by investing it in short-term notes. Therefore, the bank is yielding N$20 million on its customers’ accounts but paying back N$10 million to customers. If the central bank brings up rates by 1 percent, and the Repo rate rises from 2 percent to 3 percent, the bank will be yielding N$30 million on customer accounts. Of course, the payout to customers will still be N$10 million. This is a powerful effect. That is why whenever economic data or comments from central bank officials’ hint at rate hikes, these types of stocks begin to rally first. Winners: New borrowers Consumers may not only cut back on using credit cards, but also on buying homes and property. Most homebuyers use mortgages to finance their homes, and if mortgage rates increase, which will happen with a general rise in interest rates, the cost of owning a home will also climb. The uptake in the cost of home ownership will reduce demand for property. Housing prices have risen, but mortgage rates on both fixed and variable loans have remained somewhat lower over the past few years. This low interest rate environment helped boost home prices as the favourable mortgage conditions allowed more people to buy homes and enabled existing homeowners to refinance older, higher loans and free up cash flow. With the Repo rate hike and all market rate poised to go up, demand for new homes will fall and eventually home prices will also fall. This will be the right time for aspiring new homeowners to enter the market. Losers: Existing housing and auto owners and anyone with an adjustable loan Perhaps no sector has benefited more from low rates than housing in Namibia over the past few years. Commercial banks loan books have grown tremendously at the bank of low interest rate environment that prevailed. Currently, the market leader in the sector, controlling about 40 percent of the market share, has its mortgage book in excess of N$14 billion out of a combined loan book of more than N$40 billion (as at end of December 2015). Following the announcement, it’s expected, without doubt, that rising interest rates will push up borrowing and mortgage servicing cost for homes. Homeowners will thus feel the pinch in no time. Auto owners will not be spared from the wrath of the rising interest rates too. Total instalment credit book (a credit category comprising mostly of auto loans) is currently standing at more than N$12 billion from around N$10.5 billion at the end of 2014. All this tremendous growth was on the back of low rates, a factor that definitely plays a great role in people’s buying decisions. The cost of servicing these loans is definitely going to skyrocket following this announcement, and once again, auto owners will lose. If you are already locked in a 30-year mortgage or a loan for that matter at low rates that have prevailed over the past several years, you were probably smart and you will not lose out. Thousands of Namibians who hold adjustable-rate mortgages and other loans will end up paying more. Losers: Anyone looking for a job or raise To understand this, let’s first understand the effect of a Repo rate hike on the business investment. One of the main ways companies expand – particularly small and medium sized companies – is by borrowing from banks and investing that money in what economists call capital: the machines, buildings and software that make workers more productive and help them do their work every day. This is the way most growing companies expand, add to payrolls and tap into new markets. So, when the Central Bank raises the Repo rate, these new business loans get more expensive for companies--and again, particularly for small and medium sized companies. In turn, the interest payments on existing loans get more burdensome, cutting into companies’ cash flow. That puts a damper on business borrowing, slowing down investment in capital, and possibly translating into fewer job openings for workers in coming months. For some jobseekers, this drop in business investment is particularly bad news. Losers: Owners of bonds and bond funds Most citizens are likely to have a portion of their money, in a retirement portfolio (particularly the aged group at GIPF and other non-banking corporations), invested in bonds. Bonds, whether issued by the government or corporations, are debt instruments with prices that are sensitive to interest rates. The price of a bond varies inversely with changes in interest rates: if interest rates go up, bond prices go down. Investors who are holding onto bond portfolios, especially with fixed-rate bonds, can expect the values of those bonds to fall with a rate hike. Losers: Anyone looking to sell things to foreigners When the South African Reserve bank hiked the Repo rate, the aim was to induce the South African Rand (and the Namibia dollar) to become too strong. In as much as this was a good move, it presented a lot of dangers associated with a too-strong currency. If our local currency is too strong, it means it will be harder to sell Namibian made products globally—which would be bad for economic growth. An interest rate increase will make the ZA Rand (Namibia dollar) more attractive as an investment, causing the value of the ZA Rand (Namibia dollar) to rise against foreign currencies. A more valuable currency is damaging to exporters since it makes their goods relatively more expensive when translated to other currencies. Losers: Stock owners Many people prefer to invest in stock markets and stock prices are determined by future profits that corporations will generate. At very low interest rates, companies are able to borrow larger sums of money to fund the undertaking of projects that should yield some positive return. In a competitive market, the ability to borrow money at very low rates allows corporations to invest in projects that have narrow profit margins. Raising the cost of borrowing for a company - by even a little bit - can cause these projects to suddenly become losers, reducing profitability and lowering stock prices. Stocks are relatively expensive compared to historic levels based on earnings multiples, and a higher interest rate environment may make them look even more costly. Furthermore, as mentioned earlier, consumers may also cut back on purchases, which will negatively affect companies’ revenue numbers and cause further damage to their bottom lines. Low interest rates have also encouraged traders and speculators to bid up the price of stocks. If interest rates rise, the cost of leverage will also rise, causing stockowners to cut down their holdings by selling their stocks.
New Era Reporter
2016-02-12 11:44:32 | 4 years ago