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Should You Be Afraid Of Negative Interest Rates?

Many central bankers around the world have warmed up to the idea of negative interest rates.

There are already countries in Europe, and more recently Japan, which have seen their central bankers push through negative interest rates in a bid to stimulate growth.

In theory, in a negative rate environment, banks would actually charge depositors for depositing their money. At the moment, interest rates in Singapore are at very low levels and there are signs of the economy slowing down (the economy was flat quarter-on-quarter in the first-quarter of this year).

Should investors be afraid of negative interest rates coming to Singapore?

I hope I am not breaking anyone’s bubble, but we might have already been living in a negative interest rate environment for a few years now.

The hidden negative rate

Money is subject to inflationary pressures most of the time – in other words, S$1 today can purchase more goods as compared to S$1, say, 10 years from now.

I’m sure many of us would have heard of stories from our grandparents on how a bowl of noodles that cost S$5.00 today only cost them 50 cents when they were young. That’s an example of how inflation corrodes the value of money.

Yet, viewing money in real terms (adjusted for inflation) is hardly practiced in real life. This is called the money illusion, in which we only see money in nominal terms (unadjusted for inflation) and not its true value.

Since 2009, Singapore has been in a low interest rate environment with most banks’ deposit rates staying below 1%. Yet, inflation had hardly been below 1% as you can see in the table below. Therefore, it means that if you had saved your money in the bank since 2009, it has been losing value.

Year Singapore Inflation
2006 1.0%
2007 2.1%
2008 6.5%
2009 0.6%
2010 2.8%
2011 5.3%
2012 4.5%
2013 2.4%
2014 1.0%
2015 -0.5%

Source: World Bank Organisation

To give some context to the numbers, imagine that you have been earning a 0.3% deposit rate since 2009. Your total nominal returns from 2009 to 2015 would be 2.1% (a 0.3% return compounded for seven years). Yet over the same period, the value of the Singapore dollar has fallen by over 17% due to inflation. So, you have actually lost 15% of your wealth over the past seven years just by keeping it “safe” in the bank.

Foolish Summary

The purchasing power of money decreases with time more often than not as a result of inflation. Whether nominal interest rates are above or below 0% is of no importance – it’s what nominal rates look like in relation to inflation that matters. Although some of you may fear that Singapore might one day have negative interest rates, the thing is we might already have been living in it for a while now.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim does not owns shares in any companies mentioned above.