Suppose one morning you wake up to discover gravity had been reduced – you can now jump higher and weights in the gym feel lighter. Almost all physical activities are easier to complete. This all sounds superb, but highly improbable.
The economy has its own form of gravity known as the repo rate. And although we don’t know who controls gravity, we know it’s the South Africa Reserve Bank (SARB) who controls the repo rate. The repo rate is the interest rate at which the SARB lends to major commercial banks – think Standard Bank, Capitec, Nedbank and Absa. Yup, banks also need to borrow money sometimes too. The rate they borrow at, the Repo rate, affects the rates at which these commercial banks lend to us, the individuals.
Jumping for joy
A decrease in the interest rate has the same effect as gravity. Financially, you can jump a little higher and even if you weren’t jumping before, an interest rate decrease is a reason to jump for joy. Many individuals have some form of debt or may be wanting to purchase an item which requires them to take out a loan as they don’t have enough cash. The loaned funds could be used to finance anything from clothes to cars, studies, houses or business ventures.
The reason to jump for joy is that debt is now cheaper. You can take out more of it and the repayments on new loans are less. This puts more rands in your pocket, which could be used for additional spending – or saving. However, it would be wise for households with large debt burdens to use the additional funds to pay back more of the loaned funds. This will reduce future repayments.
The effect of lowering financial gravity
Lower interest rates increases lending. Individuals will have more money to spend and incomes increase. It’s important to understand that one person’s spending is another’s income. So with the use of credit (borrowed funds), individuals spend more which means others earn more, which allows those people to spend more. This, in turn, stimulates the economy.
A decision to lower the interest rate is usually taken when an economy is in a recession and growth forecasts are deteriorating. The SARB has decreased the repo rate twice so far during the Coronavirus epidemic.
Will your loan repayments decrease ?
It’s important to understand the terms of the existing loans. Specifically, if the loan has fixed or variable rates. If the loan is fixed, the interest rate change won’t change your loan repayments – this means that your repayments will stay the same. But remember, if the interest rate increased you wouldn’t pay more.
Conversely, a variable rate loan moves with changes in the repo rate. When it changes, the repayments on your loan change. But, interest rate moves are difficult to predict. When borrowing, you shouldn’t speculate and try to time the taking of a loan. Instead the loan needs to be assessed according to your personal financial standing – budget and income.
How gravity and interest rates differ
Unlike gravity, which we assume would help us all, there are some losers when the interest rate decreases. Savers would earn less in their interest bearing savings accounts – not the best for pensioners that may require cash to support themselves in a short period of time. Remember, the interest earned on savings accounts is linked to the prevailing interest rate – the rate the SARB decides upon. Hence, if you are young and don’t need cash right now, investing your money would be more advisable.
Moreover, while it’s intended to boost the economy, a rate cut could increase the inflation rate and decrease the rand’s strength. Both these effects are taken into consideration when the SARB takes the decision to change the repo rate. Although they don’t have a crystal ball to see the future through, they have information which allows them to assess the expected effects.