• Wed
  • Jul 30, 2014
  • Updated: 7:50am

Real rates of interest give cause to rejoice

PUBLISHED : Thursday, 24 June, 1999, 12:00am
UPDATED : Thursday, 24 June, 1999, 12:00am

The threat that high real interest rates will slow our economy down has been raised again with the news that consumer prices fell 4 per cent last month.


Take real interest rates as being short-term market interest rates less consumer price inflation (CPI) and you get a real rate for Hong Kong at present of 9.3 per cent. This is up from a negative real rate (inflation higher than interest rates) of 6.9 per cent at its greatest in 1992.


Quite a change that. As the first chart shows, it is certainly a different record from the rest of Asia.


Take the region excluding Japan (because it dwarfs the others) and the mainland (because markets don't set the rates there) and you get a weighted average real interest rate of only 3.1 per cent at the moment.


Now stop. This may be an appealing way of assessing the true burden of interest rates but it doesn't really work.


The difficulty is that inflation tells you how much prices have moved over the last year but, when you borrow money, you are not interested in history. You want to know what prices will do over the coming year and you really only want to know it for prices related to the purpose for which you are borrowing.


Take property, for instance, because it is the largest category of personal borrowing.


Let's say that you are negotiating a mortgage to buy an average urban estate flat of under 100 square metres. You can get a mortgage these days right down at the best lending rate. We'll call it 8.3 per cent.


The CPI housing component at the moment shows a drop of 4 per cent and this implies a real mortgage rate of 12.3 per cent, painfully high.


First of all, it doesn't fit because the CPI housing component measures mostly rent and few people borrow money to meet rental payments. If you're renting you're a winner on these inflation numbers.


But you're buying and prices in your type of flat had by April already risen at least 18 per cent since October last year (government figures).


Demand is up, confidence is returning, supply remains pinched, nominal interest rates are down and you are becoming optimistic.


You tell yourself, and it's an entirely reasonable assumption, that in a recovery bounce you could easily get at least that 18 per cent lift in prices for another year and your mortgage is costing you only 8.3 per cent. Do you really think this equation works to your disadvantage? In fact these comparisons of borrowing rates and the CPI do not work anyway because the CPI is about consumer prices and, aside from home ownership, only about 12 per cent of total bank lending is consumer lending, even at its most liberal definition.


It actually works the other way round.


Aside from that mortgage again (and you're winning there now), you, the consumer, are probably more of a depositor than a borrower. The average weighted deposit interest rate of banks in Hong Kong dollars is now about 4 per cent. Add in that 4 per cent deflation rate and you are getting a real return of 8 per cent.


Now let us all rejoice.


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