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Should you take out a loan during a recession?

By Athenkosi Sawutana

South Africa recently entered its second recession in two years, after the economy contracted 1.4% in the fourth quarter of 2019. When the country is facing turbulent times, personal finances also get affected, and sometimes debt becomes necessary to help purchase whatever you need.

But should you be borrowing when the country is in a recession? Justmoney spoke to economists to help you decide if this is the right thing to do.

Tip: Get a personal loan at competitive interest rates by clicking here.

What does it mean when a country is in recession?

“Officially, a recession is defined as two consecutive quarters of negative economic growth. In such instances, the Gross Domestic Product (GDP) which is the total value of goods produced and services delivered during a year, shrinks during two consecutive quarters,” says Wessel Lemmer, senior agricultural economist at Absa.

“Not only is your economy not growing, but it’s actually shrinking. The impact is felt through all sectors of the economy, and often we see mass job losses,” adds Siphamandla Mkhwanazi, senior economist at FNB.

According to Statistics South Africa, the South African economy contracted by 1.4% in the fourth quarter of 2019, following negative growth of 0.8% in the third quarter of 2019. Adding to this, the actual inflation rate of 4.6% year-on-year (in February) shows an increase in the cost of living.

A negative economic growth rate means that as a country we produce less (our total output declines). In the end, citizens become poorer as they need to buy more expensive goods with money with less buying power, says Lemmer.

"Job losses and an increase in unemployment may exacerbate the negative impact of a recession. Yet, even during a recessionary phase, not every business necessarily experiences negative growth," he adds. 

What does a recession mean for interest rates?

During times of an economic downturn, the Reserve Bank may take a dovish tone and cut interest rates in an effort to stimulate economic growth, says Lemmer.

When interest rates are lower, it’s cheaper to borrow money, which generally means consumers are more inclined to buy goods and services. It’s also cheaper for businesses to get loans to invest in machinery and equipment in order to increase production (and total output), he adds.

Given the difficult economic environment South Africa finds itself in, the South African Reserve Bank recently cut the repo rate by 100 basis points (1 percentage point), in an effort to stimulate economic growth.

READ: Reading your loan agreement: look out for this.

Is it wise to borrow when there’s an economic downturn?

South Africa already entered a recessionary cycle before the outbreak of the worldwide Covid-19 pandemic. Business confidence was also (already) at a low level. The pandemic worsened the economic outlook for South Africa and an inevitable sovereign credit rating downgrade by Moody’s followed.

“Borrowing long-term money while interest rates are low is a good way to obtain capital to expand your business as soon as the economy starts to recover. But take care: if your business isn’t doing well during the expected prolonged recession, your revenues may not cover the interest payments on your debt,” says Lemmer. 

“Before taking up credit, you should carefully consider whether there’s a real need for credit or if it can be funded from alternative sources such as savings,” advises Mkhwanazi.

If there’s a need for credit, it’s important to select the right type of credit for your situation. Only borrow the amount you need and don’t overextend yourself. Paying in extra into your loans allows you to pay off your debt quicker and helps you save on interest and fees, he says.

Mkwanazi also advises you to take up credit insurance which is offered with most loan products to protect you from unforeseen circumstances. This could cover you in the event of death, disability or the inability to earn an income.

“Another solution is to consolidate your qualifying debt from various credit providers into one convenient personal loan which means paying one instalment, one set of fees and one interest rate which could assist you to manage your money during this difficult time,” says Mkhwanazi.

It’s too soon to know how long the Covid-19 pandemic will continue to impact negatively on global economic growth. It’s equally too soon to tell when South Africa will start to recover from the negative growth path witnessed before the outbreak, says Lemmer. 

He explains that the underlying fundamentals that detracted from economic growth before the outbreak are still present. Sectors and businesses that aren’t doing too badly in the current and immediate future, may consider the timely borrowing of capital at lower interest rates. 

"It will enable these businesses to position themselves for the economic recovery that will eventually follow after the recession," he concludes. 

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