The poor get poorer as rates drop

  • Banking
  • Saturday, 24 Aug 2019

Average Malaysian households are already in debt. According to Bank Negara, the average household debt-to-gross domestic product ratio is 83%, which despite being lower than in previous years, is still considered to be on the high side for a small economy.

Conventional economic theory presumes that when interest rates are brought down, households will tend to borrow more and spend on houses, cars and themselves. However, a prolonged period of low interest rates defies conventional economic logic.

In fact, a prolonged period of low interest rates will hurt the poor and vulnerable even more, especially when they are already in debt, there is no growth in wages and the economy is slowing.

The economic theory that low interest rates will spark investments and consumption will not work in an environment where interest rates have been kept low since 2009. In fact, it has caused more uncertainty and volatility.

This is the truth as the world has witnessed when the US started to reduce interest rates.

Just when most were quite convinced that banks would offer higher fixed-deposit rates of about 5%, the reverse is happening.

Fixed-deposit rates are coming down on the back of Bank Negara reducing the overnight policy rate. Malaysia is not alone in reducing interest rates. On this score, the world, led by the US Federal Reserve (Fed), is back to reducing interest rates.

By the end of next year, analysts are expecting the Fed to reduce interest rates by as much as 100 basis points, meaning it would be down to about 1.25% from the 2.25% now. Other central banks are following the Fed’s move to lower interest rates as well, including Malaysia.

The logic is that a lower cost of funds would help businesses invest more and spur growth in the economy but it’s not happening due to several reasons.

On the back of a global trade war and the simmering feud between the US and China on tariffs, there is a disruption in the global supply chain. It has caused uncertainty. Businesses are not investing despite the lower cost of funds.

Couple that with the changing economic structure due to technology, and uncertainties abound. Even banks are not expanding, as they fear the advance of fintech could disrupt their business.

The global economy is expected to slow down to 3.2% this year from 3.7% last year. The International Monetary Fund expects some rebound to 3.5% next year, but its prediction changes every quarter.

The yield of the US’ two-year Treasury bonds has gone below that of the 10-year debt papers thrice this year, an indication of a looming recession. Despite President Donald Trump’s assurance that there is no fear of a recession in the US, in the past 50 years an inverted yield curve has preceded one.

Average Malaysian households are already in debt. According to Bank Negara, the average household debt-to-gross domestic product ratio is 83%, which despite being lower than in previous years, is still considered to be on the high side for a small economy.

When households are already in debt, they tend not to take on more debt and spend less. Worse, they get lesser returns from whatever savings they may have, be it in fixed deposit or compulsory savings with the Employees Provident Fund (EPF). Higher deposit rates help businesses more than the middle and lower-class population segments. They come in handy especially for retirees or those with the appetite to put some money away every month from their income.

For instance, assuming a household is able to save RM100 per month over a period of 20 years, at an interest rate of 5% they would see their savings increasing to RM42,663 in nominal terms. In real terms, after stripping out the inflation rate of 2.5%, it would be RM32,619 on an investment of just above RM25,000.

If interest rates come up to 3%, the nominal returns would be RM34,400. The real returns over a 20-year period would be less than RM2,000.

A prolonged environment of low interest rates also means that the lower and middle-class have to work longer years to secure a better future in retirement. Their compulsory savings in the EPF will provide lower returns because 50% of the money with the provident fund is in fixed-income instruments.

In a nutshell, prolonged low interest rates do not help those who may have saved a little to get a decent return and supplement their income. This is unless the lower interest rate environment is accompanied by economic growth, job creation and a rise in wages.

However, we are not seeing any of these elements, especially in Malaysia where wages have generally remained low for the vast majority of jobs. For instance, in the media and other service-related industries, wages have remained almost stagnant for the past three years because the industry structure itself is changing.

The employees of Utusan Malaysia are fortunate that they work in a high-profile company and their three-month salary arrears have been highlighted. There could be many others in a similar situation.

The companies cannot be blamed either, as economic conditions are tough and they tend to lay off the higher-paid employees. It’s not only here in Malaysia, even Deutsche Bank in Germany is laying off employees.

One of the reasons why some households among the middle and lower class are able to do better is because of the gig economy. Nowadays, it’s quite common to see middle-class and lower-income people driving a Grab or riding a motorcycle to deliver food.

It is a temporary solution to the growing middle class who have been squeezed out of this combination of low interest rates and slowing economic growth. On this score, the government allowing Indonesia’s popular motorcycle e-hailing service Go-Jek to operate here is a move in the right direction.

It allows the further flourishing of the gig economy. However, there is only so much the gig economy can do to help the lower and middle classes.

Dropping interest rates further does not help either, as the effectiveness of monetary policy to stimulate the economy has diminished. Now, governments have to turn to fiscal policy. Hopefully, the purse strings will be loosened when Finance Minister Lim Guan Eng announces Budget 2020.

The views expressed here are solely that of the writer.

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Banking , interest rates , poor , economy , GDP , growth , debts ,


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