Since the speculation of interest rates increment from the US has depreciated our currency, our central bank (MAS) has contemplated multiple solutions to ensure the competitiveness. Of recent, they announced that the initial gradual appreciation of our currency will be halted until further improvements in our economy.
The Monetary Authority of Singapore (MAS) does not control our local interest rates. Our domestic interest rates are largely dependent on the outlook and policies of our major trading partners, namely US, China, and ASEAN. It seemed like the world economy was turning a corner, and headed toward a gradual recovery. In line with this, interest rates were inching up.
This all came to a halt recently with several economies, including countries in Europe and Japan, adopting negative interest rates. Even USA’s Federal Reserve’s Chairman, Janet Yellen, cannot rule out adopting it.
What Do Negative Interest Rates Mean?
In layman terms, negative interest rates mean people have to pay money on deposits with banks. It could even mean people get paid money to borrow from banks.
This happens when economies are facing a bleak economic situation – where banks do not lend money freely, businesses do not want to borrow money because the growth and economic outlook is dim and people like you and I are saving money rather than spending or investing.
The central bank in the country could adopt negative interest rates to turn the situation on its head. It can incentivise people to spend and invest their money, rather than save it and see its value dwindle. This in turn would stimulate economies.
How Would Banks, Businesses And People React To This?
It would seem the banks’ reactions are the key to this question.
Theoretically, when this happens, banks are motivated to lend money more freely. This is because it has to pay the central bank to keep money with it. Banks would then lend money to businesses by charging a premium margin above the rates set by the central bank, much like how current mortgage loans work. This would still be lower than previous rates and attract businesses to borrow.
Businesses would also be encouraged to borrow money to expand, as money is cheaper than it has ever been, leading to rising growth outlooks.
Consumers would desire to do something with their money rather than put it in the banks. They could spend it on products today, invest it, start a business or just hoard it under their pillows (which would significantly stimulate the burglary and security sectors).
These measures are meant to stimulate the economy, and make it vibrant again.
Will It Work?
On the contrary, what’s been actually happening is the opposite. Banks aren’t charging consumers to keep money in their banks, fearing it may cause a run – where everyone rushes to take money out. To recover the loss of this, they are increasing loan rates on mortgages and to businesses.
Businesses are still sitting on fences, unsure of where growth opportunities lie. Many businesses with “nothing to lose and everything to gain” would be first in the queue for loans. However, are usually the ones banks try to avoid lending to.
Consumers have been investing in gold rather than in businesses, or simply spending. This can be seen with gold’s 20% rise this year (based on US dollars).
This consequently leads to the short-term effect of freezing entrepreneurship and vibrancy rather than promoting it.
Where will we eventually end up?
This is the golden question. There are many implications, and nobody can ascertain whether it will work. Essentially, central banks are running out of ammunition to kickstart economies again, and this is looking like an increasingly viable option every day.
Negative interest rates haven’t been in place long enough or widely enough to analyse and fully understand all its implications. Generally, it is thought that banks profitability would suffer, and consumers would rush to withdraw cash to avoid being charged for deposits – creating more panic and problems.
Nonetheless, while there are good cases for and against this new area of financial intermediation, neither of each side should not be taken as the gospel truth.
The Future
In all likeliness, the banking industry, and indeed the world, would undergo a transformation or an uber-isation – perhaps crowdfunding is the solution or perhaps Bitcoin and Apple Pay is the solution or perhaps something new, no one really can predict right now. Companies that adapt and innovate to help solve consumers’ problems and offer greater convenience would proliferate and the traditional institutions whose sole purpose for existing is making large profits for its top management would suffer most.
Or perhaps the global problem is that the richest 1% owns 99% of the world’s wealth. How to stimulate the economy when the rest of the 99% own so little?
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