Low interest rates

inSight

18 Oct 2001

Low interest rates

Although the purchasing power of savings continues to increase, low nominal interest rates are not good news for the small depositor.

With the interest rate for savings deposits now around 0.5%, depositors are of course not getting much interest for the money they put in the bank. But, with consumer prices still coming down, at around 1% per annum, the purchasing power of savings continues to increase, quite significantly. Nevertheless, the fact that money saved is not earning a significant nominal return is causing some concern in the community. The rapidly disappearing room for further cuts in the interest rates for savings deposits, while general downward pressure on interest rates, including of course lending rates, continues, is beginning to cause concern to bankers. Borrowers, on the other hand, have gone quiet.

We do not really have a lot of relevant experience of how depositors, borrowers and the banks behave in a low interest rate environment. We did, at the beginning of 1987, when faced with very substantial and large speculative inflows of funds into the Hong Kong dollar, have some experience of working with low interest rates, but that was a short-lived episode. Before the very low interbank interest rates had time to work through to the deposit and lending rates for the retail non-bank customers, the speculation fizzled out. The clear determination, of both the Government and the Hong Kong Association of Banks, to adhere to the linked exchange rate, to the extent of actually putting in place a framework for imposing deposit charges (negative interest rates), had there been a need to do so, did the trick.

On this occasion, there is no speculative inflow of funds. Hong Kong dollar interest rates track closely those of the US dollar, which have been aggressively adjusted downwards in an attempt to avert an economic recession. US monetary policy, which Hong Kong is mandated to import through our exchange rate link with the US dollar, is currently very appropriate for Hong Kong. I realise that this passive arrangement dictated by our monetary policy framework has been, and still is, a matter of controversy for some. But I hope there is now consensus that, at least, our current monetary policy, wherever it may have originated, of much lower interest rates, is a correct one. And I hope that the economy will respond to it robustly and that the community generally will benefit from any economic improvement that comes about.

But it is not clear how and how readily the sharply lower interest rates will work through to boost the economy. Given the concentration of the loan book of the banking system in mortgages, the behaviour of mortgage-paying households that are experiencing an increase in disposal income is I suppose an important factor. Consumption may be encouraged, but the leakage arising from Hong Kong's being a very externally oriented economy, and lately the convenience and price competitiveness of Shenzhen and other places will work to reduce the multiplier effect on domestic economic activities. Lower interest rates, by themselves, may not lead to investments increasing so significantly as to produce an economic rebound. What seems to be crucial to the Hong Kong economy is still an improvement in the global economic situation.

In the mean time, those with money to save obviously will have to accept a low nominal rate of return. The small savers in particular have cause to feel aggrieved. Chances are that they are the most affected by the sharp slowdown in the economy and the worsening of employment opportunities. Furthermore, competition within the banking sector, encouraged by the programme of deregulation of interest rates, now completed, seems to have benefited borrowers more than depositors (although a sound and competitive banking system will, in the long term, benefit both). Some banks have also recently introduced fees and charges, which may have further lowered the return to small savers.

One way of obtaining a higher rate of return is for depositors, at least those with HK$50,000 or more, to consider investing their savings in fixed income securities. A five-year Exchange Fund bond now has an annual yield of slightly over 4%, while a ten-year one has a yield of over 5% (higher for paper issued by the Hong Kong Mortgage Corporation). These are available through Market Makers and Recognised Dealers, a list of whom is published in our website, and consideration is being given to making availability more user-friendly, to cater for retail investors. But I must, of course, alert potential investors to the risks of investing in fixed income securities. Even though the interest receipt is fixed, the price of the paper may go down as well as up in line (inversely) with interest rate movements.

Joseph Yam

18 October 2001

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