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How Changes In Interest Rate Can Affect Your Investments

Business Features How Changes In Interest Rate Can Affect Your Investments
SEP 13, 2022 LISTEN

If money makes the world go round, then interest rates make the money go round. Interest rate is the amount charged for money borrowed or paid for money saved. It is usually a percentage of the actual amount of debt or savings.

In Ghana, the interest rate is set by the Monetary Policy Committee (MPC) of the Bank of Ghana (BOG). The interest rate is at 22% as and there is consensus that by the next MPC meeting, further hikes may be likely.

Central banks keep adjusting interest rates to deal with inflation and decrease in currency strength. This is exactly the case with Ghana. With record-breaking inflation of up to 31.7%, and the drop in the value of the Cedi, Ghana is in an economic crisis.

As a result, President Nana Akufo-Addo has decided to soften his stance on the "Ghana beyond Aid" and has gone to the IMF for bailout.

In July, Carlo Sdralevich of the IMF, led other staff members on a visit to Ghana to see firsthand the state of the Ghanaian economy, so as to tailor a comprehensive reform package that would suit the economy.

At the end of the visit, a statement from the IMF team was issued, highlighting Ghana’s economic predicament, and worsening debt position; and they reaffirmed that the IMF would support Ghana in its trying times.

Interest rates will have an impact on you if you do the following.

If You Import Things

Interest rates affect exchange rates which affects the trading relationship between countries. When the BOG increases interest rates, the Cedi strengthens.

However, if the BOG decreases interest rates, foreign investors will start to move their investments out, to countries with higher interest rates. As a result, the demand and value of the Cedi will decrease.

A weak Cedi due to low interest rates means you will pay more to import raw materials, and other goods from overseas. This hits bigger companies that source raw materials abroad really hard. In the end the extra production cost flows down to you as the consumer, as you pay more at the counter, and this is imported inflation.

A strong Cedi, due to high interest rates means you pay less to import from overseas, thus reducing domestic inflation.

If You Export Things

Countries with weak currencies example Japan, try to reduce importation. Rather, they encourage their citizens to patronize home grown products and focus on exportation so as to earn stronger foreign exchange.

However, countries with strong currencies may focus on importation and minimize exports. Other times, companies operating in strong currency jurisdictions, outsource manufacturing to countries with weaker currencies, so that they pay less for labor & other costs like Energy.

This is seen when American companies such as Nike outsource production to contractors in countries like Vietnam, Philippines, Taiwan, etc.

In the case of Ghana, despite having a weak currency, the country is still importing. When the BOG hikes interest rates, it is expected that Ghana Cedi strengthens. If you export at this time, you make less money when you convert your dollar export proceeds to Cedi and this is translation risk.

However, if the BOG cuts interest rates, Cedi will weaken and as an exporter, you will make more money when you convert dollar export proceeds to Cedi.

If You Trade Currencies

With forex trading, you can make profits from foreign currencies that pay interest by carry trade which involves selling a currency with a low interest rate, to buy a currency with a high interest rate.

You would have to keep your position open overnight and as you rollover your open position daily, you will profit from the difference in the interest rate, between the two currencies.

However, there is a downside to carry trades. For example if you use USD with an interest rate of 2.25% to buy Cedi with an interest rate of 22%, and hold your position overnight you will earn interest.

However, to close your position and claim your profit, you need a counterparty willing to sell USD and buy Cedi and this difficult to find.

This is why currency pairs like CEDI/USD are called exotic pairs as they have low trading volume and trade participants are hard to find.

Although forex trading isn’t regulated in Ghana, brokers from countries that regulate forex trading such as South Africa are accepting Ghana traders. There are multiple well-regulated Tier-1 & Tier-2 foreign forex brokers that are considered safe for trading for traders in Africa where there is lack of regulation for derivatives trading.

It is important to trade with those forex brokers that provide liquidity for various currency pairs, like EUR/USD, USD/JPY, etc. This is necessary so you get the lowest spreads, and can easily exit the market.

Without sufficient liquidity, you could keep your position open for many nights, and since forex trading is leveraged, you pay margin interest for as long as your position is open.

If You Invested In Bonds

A bond is a type of fixed income asset that governments and companies use to borrow money from the public. For example if you buy bonds from the Ghana treasury, you will be paid interest every year, and at the end of the bonds life, your principal is refunded to you.

When the BOG increases interest rates, older bonds become less attractive to investors as they would prefer to go for new bonds that pay higher interest. The decrease in demand for old bonds will result in a fall in its price.

On the other hand, when the BOG reduces interest rate, older bonds with higher interest rate become more enticing. Increase in demand for older bonds will cause an increase in its price. This is usually favorable to bond holders.

Also, many foreign investors are finding value in Dollar bonds issued by the Government to fund their deficit. This will also help to bring foreign currency for imports & trades.

If You Invest In Real Estate

A Real Estate Investment Trust (REIT) is a company that owns and operates income generating real estate properties like warehouses, residential apartments, and office spaces.

Firstly, if you own a REIT company that builds and sells homes, a hike in interest rates will mean you pay more for loans you took to build the homes.

This affects the prices of the homes, and they become more expensive and the demand for them drops. In the end you have to bring down the prices of the homes, to remain in business; so we can say higher interest rates, causes real estate prices to drop.

Secondly, if you have outstanding mortgage payments on a home you bought and interest rates are hiked, you may have to pay more than you were paying. This has forced many people who couldn’t meet up payments, to lose their homes.

Lastly, if you don’t have money to buy a house and you chose to buy shares of a REIT to gain exposure to real estate, you too can be affected. This is because, if the REIT company posts less profits due to low demand for its properties, its share price could fall and dividend payments could reduce or stop.

If You Have A Savings Account

With increased interest rates, banks charge you higher Interest when you take a loan and also pay you more monthly interest when you leave your money untouched for a month.

However, the interest on savings may not be so much. To make more profit from saving, you may consider savings in a high yield savings account.

On the other hand, if the BOG decreases interest rate to a point where it falls below zero (negative interest rate), borrowing may be more profitable than saving.

This is because in a situation of negative interest rates, banks pay you for taking loans. This is usually done to fight deflation by increasing consumer spending and the money in circulation.

If You Have A Current Account

Current accounts charge you interest each time you make a withdrawal, but have the advantage of convenience, as you can send someone to make withdrawal for you using a cheque book. Current account holders are also seen as more credit worthy, than savings account holders.

When interest rates are increased, you pay more interest each time you make a withdrawal and this can deplete your funds especially if you make huge withdrawals. Banks also charge current account holders for issuing cheque books, and for account maintenance.

Sensitivity to Interest Rates

You would need to always be at the watch out for adjustments in interest rate seeing that it has a major impact on investments.

Notwithstanding, it is noteworthy for you to know that Interest rate alone is not a perfect indicator that your investments will go in or against your favour.

As such, while keeping an eye on interest rate, you also want to keep an eye on other factors (like inflation, other government policies, economic growth etc.) that also have Impact in investment.

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