Q&A with CMMB Securities

Q. I hear a lot of talk in the media about the Budget — whether there is a surplus or a deficit and how the expenditure should be allocated. I understand the importance of these matters for the country, but what impact does all this have on an ordinary investor like me?

Parisram, Sangre Grande

A: While the talk about the budget may seem elevated and concerned with matters of national interest, budgetary measures do have an impact on the investment landscape and individual investors. It all has to do with interest rate levels. Whether the discussion is about the overall surplus or deficit, Government’s debt load, foreign reserves, balance of payments or taxation policy, all these variables combine to have a profound impact on the interest rate level and hence the returns you receive on your investments. It could be said that interest rates are the sum total of all the measures introduced into the budget. The way this operates is by the law of secondary effects in economics. Remember, the interest rate level in the economy is itself determined by three main factors, which are the long run real growth rate of the economy, inflation as well as changes in money supply. However, these three variables are themselves impacted by the budgetary variables. Therefore the impact on the interest rate level from budgetary measures is a secondary effect, but an effect nevertheless.

For example, if Government were running a high budgetary deficit then its borrowing requirements on the capital markets would increase. However, the primary effect of increased borrowing would be a reduction in the money supply. Of course the secondary effect of reduced money supply would be a higher interest rate level. So believe it or not, if you have funds invested in a Money Market account, which floats with the interest rate level, a high budget deficit is good news for you, all things remaining constant. Similarly a high level of foreign reserves suggests that the exchange rate would be maintained at the current level or even appreciate. An appreciating TT dollar would naturally result in a lower interest rate on TT dollar balances as stronger currencies command lower rates than weaker currencies, all things remaining constant. The appreciating dollar is the primary effect and the interest rate reduction, a secondary one. So once you understand the connectivity between these macro variables and the rate of return you receive on your investment, the budget will then assume even greater relevance to you not only from a national perspective, but the link it has to the money in your pocket as well.

Q: I’m in my twenties and would like to start building wealth to take care of my family. I am also hearing about loan sales from a number of financial institutions. Should I borrow and invest in the stock market?

Corrin, Siparia

A: First of all, you need to determine whether you would qualify for the loans you are hearing about. Approach the institution offering the loan and find out the details. At most banks the qualifying criteria usually include a debt service ratio of less than 40% and a good credit history. This would be especially so since a lot of the loan sales are being offered on an unsecured basis. If you can obtain the loan then investing in the stock market may be suitable for you. However, it is important to note that while you have to pay a monthly installment towards the loan you would not be receiving monthly cash flows from your stock market investment. You would therefore have to fund this out of your salary.  So it is important to look at your existing fixed monthly expenses and commitments and then add on what the loan installment would be to see if you could comfortably afford it. You do not want to place an undue strain on your monthly cash flow and jeopardise your necessities. Therefore, you may want to borrow the amount that would allow you to pay for expenses and the loan and still have some left for emergencies and discretionary expenditure. Also, make sure that the loan term is longer than four to five years. While the amount of interest that you pay would increase it gives you time to let the market work for you. But more importantly there is short-term volatility in the stock market and you do not want to be forced to sell off your investments to pay off your loan when the market is down. After this has been worked out talk to a broker and get some advice on the shares that are likely to perform well.