Life as many of us know, has changed in unimaginable ways. The dreams, travel plans and goals we set for #20Plenty suddenly seem like a reality that never existed. We are instead fighting a virus that has left over 125 000 dead worldwide, crippled global economies and many left unemployed.
The impact of the COVID’19 continues to unsettle many governments as they struggle to contain the spread of the virus and protect human life. Global economic outlook is also very bleak according to the International Monetary Fund (IMF), with growth expected to contract by 3%.
Bringing it closer to home, economic growth in South Africa and Lesotho is expected to decline by 5.8% and 3.1% respectively. According to the Central Bank of Lesotho (CBL), sectors most likely to be affected by the pandemic are mining, construction and textiles with growth expected to decline by 13.4%, 10.2% and 14% respectively.
Unfortunately, many Basotho are already facing retrenchment as businesses locally struggle financially due to only essential services business operational. So what does the repo rate have to do with anything and how does it affect me?
The repurchase (REPO) rate, determined by CBL at its Monetary Policy Committee (MPC) meetings is the rate at which CBL lends money to financial services providers (FSP) should they need it. The repo rate is important because it also influences the interest rate (called the prime lending rate) at which FSPs will lend you money.
The prime lending rate, currently 10% in Lesotho as at 23rd March 2020 is the rate FSPs charge their best customers. For other customers, FSPs usually add a margin on the prime lending rate depending on their risk profile. Ideally this rate should be as low as possible, because a higher interest rate, for example, would result in the borrower paying back a lot of money in terms of the interest on the outstanding capital amount.
Below we will delve deeper on how the 100 basis point decline in repo rate affects your debt specifically and how you can use it to your advantage. For purposes of this article, I will not discuss the impact this decline will have on your investments.
In order to make this as practical as possible, let’s assume Motebang, aged 32 years old working for a government ministry took a loan with a commercial bank a year ago (when Prime lending rate was 11%) to buy a BMW 1 Series Japanese import car. He agrees to repay the loan over a period of 5 years at prime lending rate plus 8% i.e. 19%. The table below illustrates the terms of the loan agreement and Motebang’s monthly instalment.
| Loan amount | LSL 80,000.00 |
| Loan term | 5 years |
| Interest rate | 19.00% |
| Monthly instalment | LSL 2, 075.25 |
At its special meeting held on the 23rd March 2020 and 14th April 2020, the MPC decided to reduce the repo rate by 100 basis points from 6.25 per cent to 5.25 per cent and another 100 basis points from 5.25 per cent to 4.25 per cent. To align with these changes, FSPs also changed their prime lending rate from 11 per cent to 10 per cent in March 2020 and then from 10 per cent to 9 per cent in April 2020.
For Motebang who has been paying his monthly instalment for 12 months now, the changes mentioned above meant that the interest rate on his personal loan has reduced from 19 per cent to 17 per cent per annum. The outstanding balance and monthly instalment also reduced as illustrated in the table below.
| Loan amount (after 12 months) | LSL 69,405.88 |
| Loan term (remaining) | 4 years |
| Interest rate (new) | 17.00% |
| Monthly instalment (new) | LSL 2,002.71 |
For many Basotho like Motebang, having some saving from the monthly loan instalments really sounds great, I mean who wouldn’t like to have a bit of cash to spend? The challenge however, is that many households in Lesotho are highly indebted and have poor levels of savings.
According to an article titled “High indebtedness of households worries IMF 40 percent of household income in Lesotho is channelled towards loan repayments and findings from 2016 indicate that more 20 percent of civil servants take less than 50 percent of their salaries home, while the rest is deducted to pay off loans and insurance premiums.
This is a great concern, especially with the uncertainty of COVID’19. It thus become important to find a balance between having cash available, saving and accelerating your debt repayment.
I am of the view that we can take advantage of the decline in the prime lending rate and use this opportunity to accelerate our loan repayments. Suppose Motebang (who still has 48 months left on the loan) decides to keep his loan instalment unchanged at LSL2, 075.25. By so doing, Motebang would have paid off his loan 2 months quicker, saving approximately LSL 1,397.32 in interest.
| Loan amount (after 12 months) | LSL 69,405.88 |
| Interest rate (new) | 17.00% |
| Monthly instalment (new) | LSL 2,075.25 |
| Loan repayment term | 46 months |
At its face value it doesn’t seem like much, but this decision will help Motebang pay off his debt quicker, giving him an opportunity to use the LSL2, 075.25 to increase savings and build up an emergency fund post the coronavirus pandemic. I will also highlight that there are many other strategies one can consider however, those are not discussed in this article.
Furthermore, I did not discuss the implication the 100 basis points decline will have on Motebang’ s savings, investments and pension funds. Basotho who are able to maintain their instalments unchanged in order to accelerate their debt repayments can consider this strategy.
Like Motebang, I would encourage you to have a meeting with your financial planner to discuss suitable options and take a holistic approach concerning your financial plan. If you are happy about your decision, speak to your FSP and ask them to leave your instalment unchanged.