So Bank Negara did another round of Interest Rate cut, reducing OPR from 2.5% to 2.0%. Soon FDs in bank will start paying lower interest, Money Market Funds will definitely follow suit.
But how low can Interest Rate go? Why is it going lower? To answer this question, it may be instructive to review what is Interest Rate.
Interest Rate can be thought of as ‘cost of capital’. Banks takes money from depositors, say at 2%, then lend it to borrowers, say at 3.95%. 2% is the cost of depositors to lend money. Banks add on their cost: administration, risk management and finally lend out money at 3.95%. 3.95% – 2% = 1.95% is said to be the Bank’s ‘Spread’.
Hang on, you say. You might not agree to lend at 2%. You might want to lend at 5%. So in the market, there are two additional players. First is Bank Negara. By declaring that it will lend at 2%, Banks will definitely go to Bank Negara to borrow money instead of you, because Bank Negara is cheaper.
2nd player in market is the international market. A US investor will look at 2% Ringgit Malaysia and compare to 0.25% US Dollar and decide if they like the 2% in Ringgit. If so, a US investor will also lend at 2% Ringgit.
Bank Negara can always lend an unlimited amount of money because they can print them. Therefore OPR is usually the benchmark to set the cost of money in Malaysia. All other countries’ Central Banks of course have their own benchmark and set their own rates. In normal practice, a country is always growing, therefore there are always new employees coming into work that needs cash to conduct economic exchange. Printing cash is not as bad as it sounds because of this demand.
However, there is room for the 3rd party:- the international market to influence the local money market by changing the exchange rate. It is usually reasonable for an investor to go for 2% when the alternative is 0.25%. But if the exchange rate loss may be too much, A US investor may still choose 0.25% USD than 2% RM just because of exchange rate loss. The exchange rate can be thought as a balancing mechanism for Interest Rate.
So you can imagine, the 3 factors affecting an Interest Rate:
- What is the return from a deposit vs lending out to borrowers?
- What is the return from a currency vs another currency?
- What is the rate of money printing in a country?
Things to consider:
- If the return from a stock market and property is going to be low, because there are so many investors, how much am I willing to go lower to get safe, lowest risk return?
- If the return from another currency is going to be low, because in other countries the economic and population growth is slowing, how much am I willing to go lower to get into a country that is more possible to grow?
- If purchasing power can be maintained and inflation is going to be low, because manufacturing robots and AI can make things faster and cheaper, how much am I willing to go lower because there is minimal inflation risk?
How low can Interest Rate go? These are some of the pertinent factors to think about and many of the smartest people on Earth are already moving towards an outcome they feel is very probable. Decipher, Decide and Park cash intelligently.