Returns on savings in danger of turning negative

By FINTAN TAN
WHEN external demand dries up, most governments of export-reliant countries aim to increase domestic demand by encouraging private consumption while ramping up public spending.
Besides fiscal measures, they have lowered key policy rates, which in turn triggered cuts in the commercial lending rates as well as the rates for savings. These cuts in interest rates worldwide have put the returns on savings in danger of turning negative, if it has not already.
In the euro-zone, the interest rate is now 1.5% after the European Central Bank cut its benchmark rate by 50 basis points on March 5.
On the same day, the Bank of England cut interest rates to 0.5%, the lowest since the bank’s founding in 1694. In the US, the federal funds rate is now zero, after the Federal Reserve cut the rates from 1% in mid-December last year.
Since November, Bank Negara has cut its key policy rate, the overnight policy rate, by 150 basis points to 2.0%. Following the cuts, the base lending rate, which is the benchmark commercial lending rate, also fell. It now averages 5.55%, according to bankinginfo.com.my.
The average rate on a conventional one-year fixed deposit (FD) account for most banks have fallen to 2.50% payable at maturity from 3.70% to 3.75% a year ago.
While the threat of crippling inflation has fallen by the wayside, there is still residual inflation. The consumer price index (CPI) increased in January by 3.9% to 111.7, compared to a year ago, due to increases in the prices of food and fuel.
The real interest rate is the rate after deducting tax and the rate of inflation. That means savers are getting a negative rate of return if one takes into account the inflation rate as measured by the CPI and compares it with the current one-year FD rate. In fact, for last year, it was minus 1.7%.
Some experts say that we just have to bite the bullet.
Fair enough, if one is young and have 25 to 35 years of employment and hopefully, saving and investment opportunities, in the future.
For savers, whether working or retired, the drop in the FD rates is not a good thing even though it is unavoidable. For those who have retired and are relying on their interest income, this will be especially hard.
If they have investments – which to the average Malaysian, are in the form of equities and property – they would have suffered losses. Inflation would have also eroded the value of government bonds, even if held to maturity. But government savings bonds, at least for the risk-averse, are still the safest.
That is why in January, the Government announced it would be issuing up to RM2bil in bonds aimed at people aged 56 and above as well as those who have retired on medical grounds.
Bon Simpanan Malaysia has a three-year tenure and offers a return of 5% per annum with flexibility for early redemption before maturity.
But as a reader pointed out in a letter to The Star in January, applicants are only allowed to subscribe up to RM50,000. He said that the Government should consider doubling the bond issuance to RM4bil and allow senior citizens to subscribe up to RM100,000. Even then, he worked out that the return will only be RM416 a month based on the RM100,000 principal sum.
The Government also announced that as part of the RM60bil stimulus package, it will issue up to RM5bil in saving bonds this year for people aged 21 and above with a maturity period of three years and an annual return of 5% to be paid quarterly.
In such a fluid environment, where recent economic indicators, whether domestic or external, have been bleak, any sort of opportunity to save for the future is welcomed, especially if it’s considered “safe”.
The situation for those who are working and contributing to the Employees Provident Fund (EPF) is just as dire. The EPF said last month that investment income for the third quarter of 2008 plunged 60.4% compared to the same period a year ago.
EPF contributors cannot expect a dividend payout similar to that for 2007, when the pension fund announced a 5.8% dividend, but it should not go below 2.5%, the minimum rate set by law.
For those who are relying merely on their EPF savings for their retirement, reports and studies have already shown that it is thoroughly inadequate.
When and if this blip in EPF dividend payouts is factored in, coupled with residual inflation, contributors may not be seeing much in terms of returns over the next few years, since economists have said that this will be a long drawn-out recession. Savers, prepare to batten down for the storm.
Source: The Star , 14 March 2009