The theme for this week would be rate cuts by central banks round the world including our very own Bank Negara and the big surprise from Fed last night.
This is the cut in respond to Covid-19 slowdown for the broad economy. Clearly, China alone had been reporting a major slowdown based on the purchasing manager’s PMI that showed drastic contraction moving forward. So, it is coming!
Going back to the headline, what’s the irony of a rate cut? We always assume that a rate cut could propel the economy forward from these instances.
i) Lower rates at the bank means you will spend more money rather than keeping it
ii) Cheaper mortgage and hire purchase which you might be interested
iii) Lower rates meant higher corporate borrowing to finance their capital expenditure
iv) Lower rates meant the government’s financing just got cheaper
True to the fact that these are the scenarios which we were taught in the 1st year economics on the effects of interest rate changes. As one progresses to year 3 of the course, things began to change. What was thought earlier could presumably be wrong after all in the real world. As though you’ve wasted year 1 altogether.
Take for example from point (i),
Lower rates at the bank which leads to you saving less and spending more money?
True. But these effects are for the long term and irrelevant for short term responses. In response to Covid-19, the government lowers rate and the stimulus package presented last week wanted to put more money in your pockets by allowing you to lower your EPF rate.
Rather than seeing increase in consumption by implementing these policies, the government is actually sending negative sentiment down the line to everyone in the country. Prior to the stimulus package, if you’re working in manufacturing, you would have experienced a slowdown such as shutting down a day every week and such.
When these policies came into the picture, this would solidify their view that a slowdown is imminent as it had been addressed at the national level. The irony here would be that central banks are providing incentives for people to spend but public sees this as bad sign as a slowdown is coming pulling back spending even more that they should.
Worst if we talk about point (iii)
Lower rates provide corporate to finance their CAPEX.
Nobody is a fortune teller here and most management can only except or predict what is going to happen. Nobody isn’t to commit fully on to a huge expenditure looking at how cheap the rates had become. When in doubt, just stay out.
Companies with cash are better off to wait for the right opportunity while companies who uses debt financing might hold back in times of uncertainty. A wrong move could see them having debt problems in the future.
Then there’s what the government can do from point (iv)
The stimulus packaged revealed last week seems to have the markets expecting construction projects to be awarded under the stimulus package. But the fact is that no infrastructure projects were thrown out to stimulate the economy.
The stimulus mainly focused on giving some leeway to the hospitality sector. At least this is something that we can applause but nevertheless, this doesn’t buff up sentiment and the economy.
Does a Rate Cut Really Help?
The big answer is NO. Nobody is going to run out and buy a house or a car just because the government lowered rates. No companies are going to further their investment not knowing how the virus issue would turn out next 3 months. It all depends on the government to move this economy from here on.
This is the reason why extreme cases can happen where a contraction can be long as well as and expansion.