Singapore Savings Bond: Cost to outweigh Benefit?

Many of you have probably heard about the Singapore Savings Bond. Essentially fixed deposit that doesn’t penalise for early withdrawal and pays you interest for however long you have been vested in the product. Eg. Buy a 10-year tenure bond and withdraw in Year 5, receive 5 years worth of interest without penalty for withdrawal.

If you don’t know about it, here are some reads:

MAS Media Release

Investment Moats: More details of the Singapore Savings Bond. Looks like my Emergency Fund now.

A lot of thoughts run through my mind after I have learnt about this product and I thought it would be good to share it and obtain some views from readers.

Credit Crunch in the making?

Now that money is unlikely to be going into FDs, this means less money for the banks to work with.  For individual savers, this is good news, but for businesses who need funds, it means hurting their pockets and the whole economy will feel it eventually because the cost of borrowing will increase. I thought it was rather smart for the government to put a cap, although undisclosed as of now, but nonetheless, we will feel the pinch indirectly. It’s not uncommon for businesses to pass on the cost to consumers(end-users). While individuals will only get to enjoy the full benefits after the full 10 years, the loss of cash flow through Fixed Deposits and a rise in interest rate for businesses will be felt immediately.

Let us not forget that banks have the ability to ‘create money’. A loan of $1 could be turned into $10 worth of credit. Less money, less credit. Are we welcoming a credit crunch? Interest rates will have to rise and businesses, especially SMEs will have to incur a higher cost to the already challenging environment. Let us not forget that interest on loans are not simply based on nominal %. It’s more like (SIBOR + fixed %) There’s a floating SIBOR rate involved and SIBOR has been climbing in recent months. So now we’re facing a situation where both the SIBOR and the fixed % is likely to rise together.

If you’re bystanding, you’re doomed.

Right now, we are assuming that everyone will participate because it only costs $500. Two groups of people will be hurt from my point of view: (1)The bystanders who do not participate or are unaware AND (2) Those who do not invest enough.

I’m not so much interested into discussing those who do not participate, but rather, I’m more worried about those who do not invest enough. As mentioned above, businesses will incur higher borrowing costs and will likely pass the cost down to consumers. Now.. Will the minimum of $500 be enough to make up for the increase in cost the businesses feel? If not, what is the impact and how much should be the minimum to negate away the increase in cost? Let us not forget that banks have the ability to multiply money, so the impact will be amplified as well. Is $500, or even the maximum cap that is undecided as of now, even enough to not increase the cost of the already high living?

Chaos in the stock and bond market!

Based on current market condition of low interest rates, we are expecting 2.4% yield over 10-years. Remember, interest rates are expected to see a hike. This indicates that 2.4% should be the minimum yield one should be receiving from either the stock or bond market because this is the risk-free rate. When the interest hike really hits, we’re looking at low yielding bonds or dividend yielding stocks likely to see movement in its price. As interest rates rise, dividend stocks and bond prices will fall because it becomes less attractive than it was.

Note that the Singapore Savings Bond’s (SSB) rates are fixed based on the prevailing SGS yields. This means floating interest. If in a artificially low interest rate environment it already is 2.4%, when interest rates eventually rises over the next few years, we’re possibly looking at it go to 3% or even higher! Wouldn’t this mean that any yield that you receiving that is less than the SSB’s becomes a worthless instrument? Risk-free of 3% VS Risky instrument <3%. My money is definitely going to the risk-free asset. Imagine the carnage to the share or bond price. The only consolation I see is that the SSB requires you to be in for 10-years to see that sort of yield which is a long time for the stock market. Companies grow their share price not just on dividend yields but for other reasons, so that’s not going to hurt too badly. However, for the bond market, I don’t think I can say the same and I think bond prices will fall considerably. Maybe I don’t know enough about the bond market, but based on the inverse relationship between bond price and interest rates, in simple theory, we should see a fall.

I will be adding points as new points come up. In the meantime, do leave a comment! I would love to hear your views.