Rising interest-rate cycle spells danger
Yesterday's decision by the United States Federal Reserve to raise interest rates will have very real repercussions for Bermuda. While the initial impact of a quarter of a percentage point rise is likely to be light — in the form of a probable small increase in monthly repayments on some mortgages and loans, and perhaps a few cents extra for savers — the bigger picture is that this signals the end of nearly seven years of “free” money.
Judging by the comments of Federal Reserve policymakers, further increases in rates will come at a gradual pace next year, provided the US economy continues to strengthen. Policymakers expect the Fed funds rate to be at about 1.4 per cent by the end of next year and 2.4 per cent by the end of 2017.
As Bermuda has no central bank, our banks take their own decisions on what rate to charge borrowers and what to pay savers. They do not move in lockstep with the US Federal Funds rate, but it is certainly one of the factors they consider because it affects the cost of the money they borrow. All in all, it would be a pleasant surprise if the banks did not increase their lending rates now.
Should the Fed continue to raise rates, borrowers in Bermuda, including the Government, should prepare for the consequences. If rates do indeed rise by another two percentage points over the next two years, the typical Bermuda mortgage holder, who was paying in the region of 6.5 per cent yesterday, could see the interest portion of their repayment increase by some 30 per cent by the end of 2017. So if that interest portion is now about $1,000, you may need to find about $300 a month extra by then.
The banks will have to weigh up the impact of asking stretched borrowers to dig deeper into their pockets; a succession of rate increases could push some over the edge. The numbers suggest many borrowers are still under stress. Loans described as “non-performing” — that is, when borrowers are at least 31 days in arrears — made up nearly 10 per cent of our banks' total loans by halfway through this year, according to Bermuda Monetary Authority figures.
For the Bermuda Government, the turn into a rising interest-rate cycle spells danger ahead. It will mean that it will have to pay at a higher rate to borrow in the future. And given that the Government's gross borrowings total a monumental $2.25 billion, it would not take much of an interest-rate increase to cost taxpayers a lot of extra money. Our debt-servicing costs for the present fiscal year already come to $170 million, more than twice as much as the annual budget for the Ministry of Public Works, for example.
Bermuda pays a fixed rate of interest on the vast majority of its debt, averaging about 5 per cent, so the Fed rate rises will have little immediate impact. The problem will come when the Island has to either borrow new money or when it rolls over chunks of the existing debt. The daunting repayment schedule is thus: $90 million is due in 2016, $180 million in 2019, $500 million in 2020, $140 million in 2022, $475 million in 2023 and $800 million in 2024.
While some of that principal will be paid off with funds set aside for the purpose in the Sinking Fund, much will have to be reborrowed, most likely at a higher interest rate.
The interest that the Government will pay on debt during this fiscal year is estimated at $117.6 million. Had it been borrowing at 7 per cent, rather than at 5 per cent, that bill would be 40 per cent, or roughly $47 million, more.
The saving grace is that the Government borrowed most of the funds when Bermuda had a higher credit rating than it does today, and when interest rates were at historic lows. Also, the bulk of the public debt will not need to be rolled over for four years or longer. This reinforces the point made by the Fiscal Responsibility Panel, in the report published last week, that Bermuda has “a window of opportunity” to improve its fiscal situation.
The panel suggested broad-based tax increases over the next three years, so it seems likely that the banks will not be the only ones requiring the public to fork out more in the coming years.
The urgency of addressing the debt situation aggressively, while we still can, cannot be overestimated, especially if we are moving into a rising interest-rate environment.
We can only hope that the authorities get the balance right between avoiding fiscal disaster and not inflicting extra hardship on those who are economically weakest in our community.