By Costas Apostolides
THE public at large should be informed that taking low interest loans in foreign currencies when your income is in euros is a high risk activity, and is really a form of gambling often involving the mortgage on their homes.
Over the past couple of weeks two friends have come up to me and stated that relatives had been persuaded by Cyprus banks to take out low interest loans in Swiss Francs, and were now in serious trouble owing to the appreciation of that currency. Despite payments made regularly, they now owe more in euro terms than when they made out the loan. This appears to be a more widespread problem than I was aware of, for normally only business people take out loan in foreign currencies or hedge their bets by buying on futures markets.
At times of crisis the Swiss Franc is considered the safest of currencies, and corporations and the wealthy put their money in the currency in case their deposits suffer from devaluation, depreciation, war or as in Cyprus a bail-in haircut. They are willing to pay the opportunity cost of low deposit rates for safety and security. Consequently the value of the Swiss currency goes up since it becomes relatively scarce in international markets.
To some extent this is also the case with the US dollar, even though the huge balance of payments deficits of the United States raise the fear of a collapse in price at some future time. But the dollar’s status as the main reserve currency in the world maintains its value as countries hold dollars as a reserve, and do not place them on the market in the way they would with non-reserve currencies.
The euro has changed in value in terms of the dollar (USD), the pound sterling (GBP), the Yen (JPY) and the Swiss Franc (CHF). It can be seen that even though there were fluctuations in currency values over the period September to September 2008 to 2013, anyone taking a loan out would have been worse off in terms of capital repayment costs if they took out loans in Swiss Francs.
For the currency appreciated by almost 28% over the five year period. There were also more moderate increases of almost 12% in Japanese Yen. The US dollar also increased in value, but by around 5% or so. In all these cases however, the cost arising from the currency revaluations has to be compared to the savings through payment of lower interest rates. Bearing in mind that interest repayments would also have risen as a result of currency fluctuations.
It is, therefore, likely that loans taken out in dollars and Yen may have broken even on overall costs; depending on the disparity in interest charges, but those who took out loans in Swiss Francs appear to have suffered significantly higher costs (currency revaluation, capital value increase, interest rate repayments, and currency conversion costs for payments).
Only in the case of loans taken out in Sterling would the borrowers have gained from currency changes, but apparently only by a modest 7% or so. In the period prior to 2008 the UK currency had fallen by over 20% against the euro, but since then it has stabilised somewhat as the Eurozone problems developed.
The value of the Euro has been fluctuating because of the economic crisis, and particularly the economic situation in Greece, Cyprus, Spain, Italy, Portugal and Ireland. Fundamentally, however, the euro has strength because the Eurozone is usually a net foreign exchange earner on trade, and as a result the currency is relatively scarce. The main driving machines for its relatively high value against the dollar are German exports, while the dollar’s weakness arises from high overseas expenditures especially in overseas conflicts. The euro values should stabilise if progress is made with the countries in difficulties and the value of the dollar should rise with reduced overseas military expenditure (assuming no wars in Syria and Iran) and if the economic recovery continues to strengthen. If the Eurozone recovers from the economic crisis as projected in a couple of years or so, then it is possible that its value in the markets will increase, reducing the burden of even the swiss franc loans.
The lesson from this is that taking out loans in foreign currency is a high risk form of gambling, and one should not get involved unless one is able to cover that risk, with savings or overseas accounts.
Costas Apostolides is chairman of EMS Economic Management Ltd ([email protected]).