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Interest rates have been falling steadily since July 2006. As
a result, returns on savings and time deposits have also declined
significantly. There are, however, investment alternatives that can
provide better returns in the current climate of falling interest rates.
The inflation rate has fallen significantly since the last quarter of
2006. This has given room to the central bank, Bank Indonesia, to ease
its tight monetary policy.
Indeed, anticipating the prospect of lower inflation, the central bank
first started to cut its benchmark rate (BI rate) in May 2006. By
February 2007, the BI rate had fallen to 9.25 percent, much lower than
its level of 12.75 percent prior to the central bank's decision to ease
monetary policy.
The devastating flooding that occurred in the Greater Jakarta area
recently might exert some upward pressure on prices.
Nevertheless, the ramifications of this month's floods are likely to be
limited given that the flooding only lasted for a relatively short
period of time. As such, inflation for the rest of the year is very
likely to remain under control, and to hover around 6 percent.
Against this backdrop, there is room for the central bank to further
lower its benchmark rates. The BI rate is expected to fall below 8
percent by the year end.
Low interest rates are good news for the economy since they will help
spur economic activity. However, this is to the detriment of those who
save their money in either time deposits or savings accounts. This is
because, following the fall in BI rates, interest rates on time
deposits and savings accounts have also fallen significantly. The
deposit interest rate is now about 8.5 percent.
As a result, the return from putting money in time deposits and savings
accounts is not as attractive as it was previously. Indeed, some
time-deposit holders are already voicing their dissatisfaction in
regard to their lower earnings from their time deposits. And they will
probably be screaming louder in the near future given that interest
rates are likely to fall to an even lower level.
Fortunately, there are alternative investment instruments that may
provide higher returns. Government retail bonds, or ORI (Obligasi Ritel
Indonesia), are one investment instrument that offer much better
returns compared to time deposits. These retail bonds have been
specially issued to cater to the needs of individual investors.
And, as the smallest ORI denomination is Rp 5 million, they are
affordable to small investors. Looking ahead, the Indonesian government
plans to issue retail bonds again sometime in March. And the interest
rate offered on these bonds is likely to be between 9 and 10 percent,
significantly higher than the rates offered on time deposits.
The default risk of investing in retail bonds is almost zero, given
that they are guaranteed by the government. Furthermore, the yield on
the bonds is paid every month -- another attraction for investors.
Besides ORI, another investment alternative is mutual funds. The risk
on this type of investment instrument, however, may be much greater, as
seen during the crash of the mutual-fund industry in 2005, when there
was a massive withdrawal of funds following the rise in interest rates
that year.
In Indonesia, the mutual-fund industry is dominated by fixed-income
funds whose main investments are made in government bonds.
The price of government bonds is inversely related to interest rates,
meaning that the price falls if there is a rise in the interest rate.
As such, when the central bank raised interest rates in March 2005, the
value of fixed-income funds fell accordingly, thus prompting a massive
sell-off in the mutual funds industry.
At the present time, however, the price of government bonds is likely
to increase given that interest rates are likely to fall further going
forward. This means investors will receive capital gains in addition to
the coupon yield payments on the bond.
Mutual funds investing in fixed-income instruments also offer better
returns than time deposits.
In addition, investors may also invest directly in bonds (be they
government or corporate bonds). Investing directly in bonds is suitable
for those who are already familiar with the bond market and can
tolerate a slightly higher risk. Bonds also offer better returns
compared to time deposits.
For example, a long-term note (with a maturity of 5 to 10 years) offers
a higher interest yield of around 10 to 14 percent before tax, or
significantly higher than the return on time deposits or savings
accounts.
Furthermore, the risk of capital loss is very small given that interest
rates are likely to fall further going forward (remember that bond
prices move inversely to interest rates).
For those investors who seek a much higher return -- and can also
tolerate a greater level of risk -- the stock market offers even higher
potential returns. Last year, the Jakarta Stock Exchange Composite
Index (JCI) rose by more than 50 percent -- far more than time deposits.
Currently, the JCI is already at a high level. But this does not mean
that the stock market does not have the potential to rise further
(since lower interest rates may help to support further gains in stock
prices).
This is true because low interest rates mean brisker economic activity,
and, therefore, better earnings prospects for companies operating in
Indonesia -- including, of course, those companies listed on the
Jakarta Stock Exchange. As a result, share prices may increase
significantly.
But, for those who are not familiar with the stock market, it is better
to invest in a mutual fund that invests in shares first in order to get
accustomed to how the stock market works.
In conclusion, putting money in time deposits or savings accounts does
not result in an optimal return in the current environment of falling
interest rates. Accordingly, investors should consider other
alternatives (such as government retail bonds, mutual funds, corporate
bonds or stocks), that might provide better returns.
But just remember: in order to reduce risk, do not put all your
investments in one basket. Happy investing!.
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