With predictions of further cuts in interest rates by the SA Reserve Bank, what does this mean for your finances?
I spoke to Nthabiseng Ts’oanamatsie-Zuma, a senior economist, to help us understand the role of the Reserve Bank and how it uses interest rates to influence the economy.
Countries around the world are using monetary policy to tackle the economic fallout from the Covid-19 coronavirus pandemic, and South Africa is no exception.
At the time of writing, the Reserve Bank had cut the benchmark interest rate – the repo rate – by 200 basis points for this purpose, bringing the total rate cuts this year to 225 basis points, with more cuts expected.
The last time the Reserve Bank cut interest rates this drastically was during the 2008/09 global financial crisis. Currently, it is expected that the lockdown is going to bring about an even deeper recession than the one we experienced last time.
Expansionary monetary policy, which includes the lowering of interest rates, is normally undertaken by central banks to stimulate economies, particularly in times of economic downturn, such as the current one.
In South Africa’s case, this is done by the Reserve Bank.
The interest rate cut is meant to stimulate demand as borrowing becomes cheaper for both businesses and households. This means that it becomes cheaper to service debt.
On the contrary, savers earn less interest on their savings. Therefore, lower interest rates benefit borrowers at the expense of savers.
Nevertheless, the current rate cut should benefit many South Africans, as a lot of people are highly indebted. The ratio of household debt to disposable income stood at 72.8% last year.
This means, on average, South Africans’ household debt makes up to 72.8% of their after-tax income. This is high and undesirable as it shows that households are more susceptible to negative economic conditions.
The interest rate cut is meant to assist South Africans who are now paying less on their debts, while also helping struggling businesses service their debts at lower rates amid the coronavirus pandemic.
So how does this decrease in interest rates affect the different aspects of your financial life?
If you have savings in a normal bank account, for example, you will find that the decrease in interest rates will have a negative impact on your savings. The lower the interest rates go, the less interest you earn on your savings.
Interest rates and bonds have an inverse relationship – when interest rates rise, bond prices fall, and vice versa.
This makes it a good time to consider diversifying your portfolio – by investing in bonds right now.
And the easiest way to do this as an individual is through the SA Retail Savings Bonds at gov.za/faq/money-matters/how-do-i-invest-rsa-retail-savings-bonds or by investing in an exchange-traded fund that tracks bonds.
Credit card, personal loan and overdraft
If you have any form of debt, the lower interest rates mean that your monthly repayments will in effect drop as well.
If you can afford to continue to pay what you were paying before the interest rate cut, this is an opportunity for you to pay off your debt much faster. This will save you thousands of rands in interest in the long run.
When you sign a contract for a bond, you often have a choice between a fixed rate or a variable interest rate.
If you chose a variable rate, with every interest rate cut your bond repayments become cheaper.
Instead of celebrating paying a lower monthly instalment, ask your bank to keep your repayments the same as before the rate cuts.
By doing this simple exercise, you will save thousands of rands in interest and pay off your house more quickly.
With lower interest rates, it means that your monthly car instalment will be lower as well, easing the financial pressure.
There are many benefits to the interest rate cut, but it is especially beneficial to people whose income has been negatively affected by the coronavirus crisis.
Overall, the lower interest rates also present a huge advantage to those who can afford to pay off their debts.
If you are lucky enough to be in this position during this uncertain time, continue to pay the same amounts you were previously paying on your debts. You can easily call your banks and arrange this.
The interest rate cuts are an opportunity for you to get out of debt quickly and not go into more debt.
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