Floris Slabbert, National Sales Manager of Ecsponent Financial Services, looks at some of the implications of rising interest rates
Q: How do rising interest rates affect our economy?
A: The recent interest rate increase was largely attributable to inflationary pressures in 2015. However, further increases are still likely due to additional inflationary pressures. These factors include the drought that will send up food prices, the declining value of the rand against world currencies, as well as the rising interest rates expected in the USA.
Poor international growth and unemployment saw the US Federal Reserve taking the decision in December to increase the federal funds rate, the first increase in seven years.
Locally, it’s often believed that interest rates are increased to stabilise the rand, however Reserve Bank Governor, Lesetja Kganyago has affirmed that the bank doesn’t interfere with currency movements and it is the bank’s view that no amount of intervention will stem the depreciation of the rand.
The increased rates should however have a positive effect on foreign capital invested in South Africa, largely because of the better returns it presents to international investors who due to the higher rates will be encouraged to keep their investments in South Africa.
Consumers on the other hand, will not only have to deal with the impact of the weakening rand and rising interest rates, but also the countrywide drought that has forced the importation of staple foods for the first time in more than a decade, bringing about a dramatic rise in food prices.
Those paying off bonds, cars and other debt will feel the pinch of rising interest rates and lenders are already seeing an increase in the number of defaults. We recommend that consumers consider the option of fixed interest rate, as further hikes are almost certain.
Q: What impact will rising interest rates have on investments?
A: All interest-linked investments will be positively affected as they are experiencing the best interest rates in five years.
Q: How will further interest rate hikes affect households?
A: With one-third of consumers borrowing money to pay off existing debt, according to a report issued by Trans Union during the last quarter of 2015, the outlook for consumers is bleak.
It is expected that many highly-indebted consumers will find themselves trapped in a vicious debt cycle from which they cannot easily escape. We recommend making prudent buying decisions and avoid entering into new debt agreements as far as possible.
Q: What is the likely impact on the exchange rate?
A: Higher interest rates increase the attractiveness of a country as an investment destination and foreign investment is likely to drive up local investment values and could improve the currency in the longer term. In my opinion, it is not advisable to take money out of the country now and investors looking to invest offshore in a dollar-based investment may have already missed the boat.
Even if the rand should strengthen against the dollar, investors will not only be out of pocket in terms of the loss in currency conversion, but the yield will most probably not be enough to cover management and administrative fees within the first two to three years.
When it comes to offshore investments investors should always take their full financial portfolio into account. Here it is important to consider the exposure they already have through their pension and retirement funds to mitigate the risk of finding themselves overexposed to dollar-based investments as we saw in 2008.
However, there appears to be ample opportunity in local markets and our advice is to hold on to rand-based investments until the exchange rate improves.
Q: How can investors and households prepare for a hike in the interest rate?
A: South African consumers are facing a challenging year and we suggest that investors meet with a financial planner every few months to discuss their budget and financial affairs. It’s essential to have an investment plan and revise it regularly to ensure you’re not overexposed in specific asset classes (locally or abroad).
This year, economists expect an increase of between 0,25% and 1% in the prime lending rate. An increase of 0, 25% will translate to an additional R162 per month on a bond of R 1 million. This will mean consumers will have to save on their monthly expenses to subsidise the increased premiums.
Whether it’s reducing an insurance premium or DSTV subscription fee, or eating out less frequently, we will all have to tighten our belts to find ways to subsidise the effect of rising interest rates on our monthly budgets due to increased bond and vehicle repayments.
However, when interest rates go up there will always be winners and losers. In most cases the winners will be the savers, i.e. the people who have invested in bank deposits and prime-linked investments, while the losers will be borrowers who have not made prudent financial decisions.
When it comes to combating inflation in order to maintain living standards, ordinary investors will need a return of at least 9% to 12% per annum. These yields will be more easily achievable through the rising interest rates.